KG 
.601 


Southern  Branch 
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University  of  California 

Los  Angeles 


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This  book  is  DUE  on  the  last  date  stamped  below 


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i  NOV  2     mdk 

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AUG  1 5  1960 


/ 


AMERICAN  BANKING 


H.  PARKER  WILLIS,  Ph.  D. 

Secretary,   Federal  Reserve  Board;   Former  Associate  Editor, 

Ne-iju  York  Journal  of  Commerce;  Former  Professor  of 

Finance  and  Dean,  College  of  Political  Science, 

George  Washington  University. 


La  Salle  Extension  University 
-     C  Ki  c  a  g^o     - 

1917 

5^575 


Copyright  1916,  1917 
La  Salle  Extension  University 


CONTENTS 


I.    Modern  Banking  Functions 

Services  to  the  Individual 2 

Economic  Services  of  Banks 2 

What  Is  Credit? 4 

Credit  Function  of  the  Bank 6 

II.    Classes  op  Banks 

Legal  Status  of  Banking 10 

National  Banks 12 

State  Banks • 1^ 

Private  Banks ^^ 

Loan  and  Trust  Companies 15 

Savings  Banks 1^ 

Building  Loan  Associations 1'^ 

Insurance  Companies 18 

National  Banking  Systems 20 

III.    The  Bank  Loan 

More  Complex  Transactions 23 

The  Discount 24 

Another  Form  of  the  Transaction 25 

Collateral  Loans 26 

Call  Loans 27 

Special  Collateral  Loans 27 

Documented  Bills  of  Exchange 28 

Documented  Bills  in  Foreign  Trade 29 

Bankers'  Acceptances  31 

V 


vi  Contents 

IV.     Special  Problems  in  Loans 

Testing  the  Borrower 34 

Studying  Credit  35 

Buying  Paper 36 

Rediscounts    38 

Rediscounting  under  the  Reserve  Act 39 

Commercial  Purpose  of  Loans 42 

Single-Name  v,  Double-Name  Paper 44 

The  Note  Broker 46 

Actual  Bank  Loans 47 

Specializing  in  Loans 48 

V.    Bank  Deposits 

PIoAv  Deposits  Are  Made 51 

Classes  of  Deposits 52 

Nature  of  the  Deposit 54 

Relation  to  Currency 55 

Distribution  of  Deposits 56 

Cancellation  of  Deposits 57 

Significance  of  Deposits 59 

Volume  of  Deposits 60 

Inter-Bank  Deposits 61 

VI.    Domestic  Exchange 

* '  Exchange ' '  Function   64 

Mechanism  of  Exchange 65 

Reasons  for  High  Exchange  Charges 67 

Checks  Treated  as  Cash 69 

VII.    Foreign  Exchange 

Financing  Foreign  Trade 74 

Foreign  Trade  Acceptances 76 

Older  Modes  of  Financing 78 

Movements  of  Money 79 

Loans  in  International  Trade 80 

Foreign  Operations  of  Reserve  Banks 82 

Some  Contjlusions  83 


Contents  vii 

VIII.    Bank  Notes 

Nature  of  the  Note 85 

Relation  of  Notes  to  Currency 86 

Protecting  Notes 87 

"Why  Notes  Are  Issued 89 

Note  Inflation  91 

Theory  of  Note  Issue 92 

Redemption   of  Notes 93 

Ultimate  Security  of  Note  Issues 95 

Difficulties  of  Bond  Security 96 

Federal  Reserve  Notes 98 

Issue  of  Federal  Reserve  Notes 99 

Federal  Reserve  Bank  Notes 101 

Note  Elasticity   104 

IX.    Clearing  Houses 

Growth  of  Association  in  Banking 107 

Nature  of  'Clearing  Houses 108 

The  Clearing  Process 109 

Clearing-House  Cash  Ill 

Significance  of  Clearings 112 

Out-of-Town  Checks    114 

Provision  for  National  Clearance  System 116 

Gold  Settlement  at  Washington 118 

Strengthening  Confidence 120 

Clearing-House  Certificates 123 

Certificates  an  Extreme  Remedy 124 

Emergency  Notes 125 

War  Finance 127 

Moratoria   130 

Other  Associative  Activities 131 

X.    Bank  Organization  and  Administration 

Organizing  the  Bank 133 

Payment  of  Capital 134 

Officers  of  the  Bank 135 

The  President 135 


viii  Contents 

Vice  Presidents 136 

Other  Officers    137 

Cashier's  Duties  139 

Paying  Teller   140 

Receiving  Teller  141 

Note  Teller 142 

The  Discount  Clerk 144 

Bank  Bookkeeping 144 

XI.    Capital  and  Reserves 

The  Bank  as  a  Going  Concern 147 

Creating  a  Surplus 148 

Undivided  Profits 150 

Reserve     152 

Origin  of  Reserve  Grouping 154 

Transfer  of  Reserves  under  New  Act 156 

Effect  of  Federal  Reserve  Act 159 

Restoring  the  Reserve 162 

Rate  of  Discount 163 

Relieving  Hard-pressed  Banks 165 

Protection  of  Rediscounts 168 

Making  Rates  Effective 169 

Discount  V.  Purchase 171 

Protecting  the  Notes 173 

"Guaranteeing"  Liabilities  174 

XII.     The  Bank  Statement 177 

XIII.     Government  and  Banking 

Principles  of  Control 186 

Regulating  Loans 187 

Prohibited  Loans   187 

Restriction  on  Loans 188 

Requirements  as  to  Reserve,  etc 189 

Oversight  of  Loans 190 

Inspection  and  Examination 193 

"Work  of  Examiners 194 


Contents  ix 

Bank  Reports   195 

Functions  of  the  Comptroller 196 

Control  of  State  Banking  Systems 197 

Direct  Governmental  Control 198 

Control  of  the  Interest  Rate 199 

Government  Deposits 200 

Government  Aid  to  Banks 201 

XIV.    History  of  Banking  in  the  United  States 

First  Bank  of  the  United  States 206 

Early  Growth  of  State  Banking 208 

Second  Bank  of  the  United  States 209 

Lessons  of  Central  Bank  Experience 211 

Development  of  State  Banking 212 

New  England  System 213 

Suffolk  System   214 

New  York  Systems 216 

"State  Banks"  217 

Growth  in  Soundness 218 

Independent  Treasury  System  Established. .  .219 
Banks  and  the  Treasury 221 

XV.     The  National  Bank  Act 

Nature  of  the  Act 224 

Development  of  the  System 226 

Rise  in  Price  of  Bonds 228 

Growth  of  a  Government  Surplus 230 

Deficit  Financiering 231 

Act  of  1900 233 

Surplus  Difficulties    234 

Panic  of  1907 235 

Currency  Legislation  of  1908 236 

XVI.     The  Federal  Reserve  Act 

History  of  the  Act 240 

Essential  Features  of  Original  Bill 241 

Congressional  Action  on  the  Bill 246 

Sources  of  the  Bill 250 


X  Contents 

XVII.     Control  of  the  Federal  Reserve  System 

The  Federal  Reserve  Board 255 

Administrative  Duties 256 

Constructive  Duties 258 

>Y  Educative  Functions  260 

Organization  of  the  Board 2614- 

Comptroller  of  the  Currency 262 

Secretary  of  the  Treasury 262 

Bureau  of  Audit  and  Examination 263 

Division  of  Reports  and  Statistics 264 

Division  of  Clearing 264 

Supervision  of  Reserve  Banks 265 

Board  of  Directors 265 

Federal  Reserve  Agent 266 

The  Federal  Advisory  Council 267 

XVIII.     Government  Finances  and  the  Reserve  System 

The  Independent  Treasury 269 

Defects  of  the  Independent  Treasury  System,  .272 
Government  Banking  in  Foreign  Countries.  .  ,275 
The  Reserve  System  and  Fiscal  Management.  .277 

XIX.    The  Federal  Reser\t<:  System  in  Operation 

System    280 

Regional  Character  of  Banks 280 

Branch  Banking 283 

Broad  Principles  of  the  Plan 285 

An  Act  in  Aid  of  Business 287 

Reduced  Collection  Charges 289 

Effects  Economy  in  Gold 290 

Aid  in  Foreign  Trade 292 

Relation  to  Industry 294 

Unifying  the  Banking  System 296 

XX.    Banking  in  the  United  States  aiu)  Abroad 

The  Bank  of  England 301 

English  Joint-Stock  Banks 304 


Contents  xi 

Scotch  Banking  System 305 

Bank  of  France 308 

The  Reichsbank 311 

Canadian   Banking   System 315 

Branch  Banking 318 

Other  Banks   319 

Principal  Types  of  Banks 319 

Characteristics  of  Modern  Banking  Systems. .  .321 

XXI.     Problems  of  American  Banking 

Question  of  Crises  and  Panics 323 

How  Reserve  Banks  Meet  the  Situation 325 

Comparisons  of  Reserve  Banks 327 

Relations  to  State  Banks 329 

Admittance  of  State  Banks 329 

Advantages  and  Disadvantages  of  Membership .  331 

Relations  with  the  Government 334 

Relations  with  the  Treasury  Department 336 

Development  of  Commercial  Paper 339 

Foreign  and  Domestic  Acceptances 341 

Question  of  Branches 342 

Use  of  American  Banking  Resources 348 

Financing  Exports 349 

Long-Term  Credits  Necessary 350 

Obligations  upon  the  Banks 351 

Responsibilities  upon  Business  Men 352 

Dollar  Exchange 354 


AMERICAN  BANKING 

CHAPTER  I 

MODERN  BANKING  FUNCTIONS 

A  London  financial  expert  soon  after  the  passage  of 
the  Federal  Reserve  Act  wrote  these  significant  words : 

The  act  is  a  bigger  thing  by  all  odds  for  the  world's  trade 
than  the  Panama  Canal.  The  passage  of  the  measure  was  a 
greater  discovery  than  half  a  dozen  African  gold  fields. 

That  striking  statement  with  reference  to  one  aspect 
of  banking  emphasizes  the  tremendous  force  and  power 
of  banking  in  modern  economic  life.  Recent  experiences 
have  awakened  keener  public  appreciation  of  the  funda- 
mental problems  in  banking.  Finance  in  all  its  relations 
is  very  intimate  to  all  of  us.  Business  men  are  seeing 
more  clearly  the  business  services  which  a  good  banking- 
system  is  capable  of  rendering  them,  pro\dded  it  is  used 
intelligently  and  understandingly,  and  the  nation  as  a 
whole,  after  many  bitter  experiences  with  an  inadequate 
and  archaic  banking  machinery,  has  awakened  to  the 
national  and  international  importance  of  a  scientific 
money  and  banking  system. 

Banking  from  whatever  aspect  it  is  approached  is 
interesting,  fascinating,  and  romantic.  AVhether  we  con- 
sider the  magnificence  of  certain  banking  buildings,  the 
almost  incomprehensible  figures  of  banking  statistics,  or 
the  fortunes  of  individual  bankers  who  have  won  world 
fame  and  distinction,  there  is  much  to  arouse  the  imagi- 

1 


2  American  Banking 

nation  of  one  who  is  deeply  interested  in  modern  business 
and  finance.  Yet  banking  is  to  most  people  a  closed  book. 
Banking  operations  run  a  mysterious  course  of  their  own 
and  are  little  understood  even  by  those  who  are  depend- 
ent upon  banking  services.  Both  business  and  the  banks 
themselves  suffer  from  this  lack  of  exact  knowledge  on 
the  subject. 

Banking  functions  may  for  convenience  be  considered 
from  two  points  of  view,  though  ultimately  and  finally 
the  two  interests  merge  into  each  other.  These  two  inter- 
ests are  those  of  the  individual  as  a  user  of  banking 
services  and  of  the  bank  as  an  institution  in  our  economic 
system. 

Services  to  the  Individual 

The  individual  as  a  customer  of  the  bank  sees  problems 
primarily  from  the  point  of  view  of  his  own  personal 
interests.  He  thinks  of  the  bank  as  a  place  for  the  safe- 
keeping of  money  and  other  valuables.  When  he  needs 
additional  funds  he  goes  to  the  bank  for  loans,  or  dis- 
counts there  commercial  paper  that  he  may  have  in  his 
possession.  By  means  of  his  checking  account  he  uses 
the  bank  as  a  convenient  and  safe  paymaster.  He  depos- 
its his  drafts,  checks,  coupons,  and  other  valuable  papers 
with  the  bank,  which  then  acts  as  a  collection  agent  in 
collecting  these,  often  without  charge,  from  their  various 
sources.  He  seeks  banking  advice  and  services  in  making 
investments,  in  deciding  upon  business  policies,  in  obtain- 
ing credit  information,  and  in  many  like  affairs  of 
business.  A  good  banking  comiection  and  the  ability  to 
use  it  effectively  are  positive  assets  to  the  business  man. 

Economic  Services  of  Banks 

The  foregoing  are  the  more  obvious  functions  of  a 
bank,  but  these  could  not  be  performed  in  an  efficient 


Modern  Baulking  Functions  3 

manner  without  an  understanding  of  the  nature  of  a 
bank  and  its  economic  functions  in  modern  society. 
According  to  some  writers  on  banking,  the  earliest  idea 
of  the  bank  was  that  of  a  safe  place  of  deposit.  Persons 
having  valuable  goods,  coin,  bullion,  precious  stones,  etc., 
desired  to  find  a  place  of  safety  for  them  and  so  took 
them  to  an  institution  whose  duty  it  was  to  safeguard 
the  property.  Later,  it  is  said,  these  institutions  began 
to  make  loans  and  to  state  the  value  of  these  loans  in 
terms  of  a  uniform  currency.  Functions  of  exchange 
were  taken  up,  bank  notes  were  issued,  and  gradually 
the  first  primitive  banks  were  developed  into  something 
resembling  the  institutions  of  today. 

It  is  of  no  immediate  importance  whether  the  histor- 
ical and  antiquarian  accounts  of  the  origin  of  banking 
are  correct  or  not.  The  bank  of  today  finds  its  reason 
for  existence  in  conditions  of  commercial  life  which  have 
only  incidentally  to  do  with  the  question  of  uniformity 
of  currency  or  the  safe-keeping  and  storage  of  money 
and  valuables.  Like  manj^  another  institution,  the  bank 
has  developed  far  away  from  its  earliest  origins,  and 
now  finds  its  principal  function  in  the  performance  of 
duties  which  at  the  start  were  a  minor  part  of  its  work 
or  were  not  even  recognized  at  all. 

Banks  of  today  may  be  divided  into  several  great 
classes,  such  classification  being  based  upon  principles 
which  will  presently  be  indicated,  but  throughout  all 
runs  a  single  dominant  idea  or  function.  This  function 
is  that  of  supplying  credit  in  some  form  or  other  to 
persons  who  need  it.  Or,  to  state  the  thought  in  another 
way,  it  is  that  of  guaranteeing  the  limited  or  individual 
credit  of  each  individual  by  accepting  it  and  substituting 
in  lieu  thereof  the  bank's  own  credit.  When  an  individ- 
ual takes  his  own  secured  note,  for  example,  to  a  bank, 


4  American  Banking 

discounts  it,  and  then  draws  checks  against  his  account 
at  the  bank,  he  has  simply  substituted  the  bank's  credit 
of  more  general  acceptability  for  his  own  credit  of  lim- 
ited acceptability.  The  discount  which  the  bank  retains 
is  the  value  of  this  ser\dce  to  him  and  is  the  price  he  is 
willing  to  pay  for  it.  The  bank  thus  appears  as  an  insti- 
tution for  the  study  of  credit  and  for  guaranteeing  its 
judgment  on  that  subject. 

What  Is  Credit? 

The  definition  of  the  bank  thus  given  depends  upon 
the  definition  of  credit.  There  has  been  a  great  deal  of 
more  or  less  abstract  speculation  about  credit  and  its 
nature.  We  shall  not  endeavor  to  go  into  this  contro- 
versy, but  shall  content  ourselves  'svith  merely  stating 
some  generally  accepted  facts  about  credit  and  its  rela- 
tion to  banking. 

By  a  credit  transaction  is  meant  one  which  is  not 
finally  closed,  there  remaining  a  future  payment  to  be 
made  on  one  side  or  both.  X  may  obtain  goods  from 
a  retail  shop-keeper  ''on  credit."  This  means  that  the 
shop-keeper  has  supplied  the  goods  to  X  without  receiv- 
ing money  in  payment,  trusting  X  to  pay  him  at  some 
time  in  the  future.  He  may,  however,  have  received  X's 
note  for  the  amount,  in  which  case  the  transaction  is 
based  on  credit  just  as  truly  as  if  no  such  note  had  been 
given.  The  transfer  of  the  note  places  the  shop-keeper 
in  a  somewhat  better  position  for  the  purpose  of  collect- 
ing the  obligation  when  it  is  due,  but  the  essential  nature 
of  the  transaction  is  the  same  in  one  instance  as  in  the 
other. 

In  a  similar  fashion,  if  A  and  B  are  shop-keepers  side 
by  side,  and  each  buys  goods  of  the  other,  no  money 


Modern  Banking  Functions  5 

passing  and  the  transactions  occurring  at  irregular  dates, 
what  has  really  happened  has  been  an  exchange  of  goods 
against  goods.  If  A  had  exchanged  100  pounds  of  leaf 
tobacco  against  an  equivalent  quantity  of  grain,  the 
transaction  would  not  have  been  of  a  credit  character  but 
a  plain  case  of  barter,  in  which  the  transaction  was  fin- 
ally closed  by  the  transfer  of  the  goods  on  either  side 
and  the  corresponding  receipt  of  the  goods  for  whicli 
the  trade  was  made.  In  the  case  of  the  two  shop-keepers, 
each  of  whom  buys  from  the  other  goods  whose  value  is 
stated  in  terms  of  money,  without  matching  goods  against 
goods,  credit  has  been  used  to  offset  the  transactions 
against  one  another  so  as  to  be  final,  but  this  is  possible 
partly  because  the  exchanges  have  been  based  upon  a 
scale  or  level  of  prices  previously  fixed  by  the  community 
at  large. 

Going  a  step  further,  we  may  suppose  that  neither  of 
these  shop-keepers  pays  money  and  that  neither  expects 
to  liquidate  the  indebtedness  by  matching  accounts  with 
his  customer.  Each  pays  the  other  from  time  to  time  by 
giving  him  a  claim  upon  some  third  person  or  institu- 
tion who  owes  both.  Such  claims,  being  of  known 
goodness,  are  readily  accepted.  This  introduces  a  new 
factor  into  the  situation  and  suggests  one  way  in  which 
the  bank  becomes  a  party  to  commercial  transactions. 

It  may  be  asked  why  either  of  the  traders  should 
want  to  fall  back  upon  a  bank  in  this  way.  That  may  be 
merely  a  matter  of  convenience.  Neither  of  the  men  may 
care  to  keep  actual  money  in  his  establishment  and  so 
may  hand  it  over  to  the  bank  and  transfer  title  to  it  as 
he  sees  fit  by  means  of  a  check  or  credit  instrument.  In 
such  a  case  the  bank  would  be  merely  exercising  its 
primitive  function  as  a  place  of  safe  deposit. 


6  American  Banking 

Ceedit  FmsrcTioN  op  the  Bank 

But  this  in  tlie  commercial  world  would  be  only  the 
unusual  case.  Individuals  would  not,  in  practice,  keep 
sums  of  money  idle  in  banks.  Nor  is  it  true  that,  under 
modern  conditions,  every  man  could  carry  on  all  his 
business  through  the  agency  of  actual  money  whether  he 
handled  it  himself  or  left  it  with  a  bank  and  transferred 
the  title  to  it  on  paper. 

In  order  to  render  possible  the  commercial  transactions 
of  the  present  day,  what  is  needed  by  the  ordinary  trader 
is  a  means  of  making  clear  to  his  creditors  the  fact  that, 
at  some  time  in  the  future,  he  will  undoubtedly  be  able 
to  control  money,  the  universal  medium  of  exchange. 
If  he  owned  a  stock  of  universally  desired  commodities, 
he  might  liquidate  his  obligations  by  giving  written 
claims  on  such  commodities  to  his  creditors.  No  such 
commodities,  except  money,  exist,  and  what  he  needs, 
therefore,  is  the  guarantee  of  some  authorized  and  known 
person  or  institution  that  he  can,  upon  due  notice,  convert 
the  wealth  he  owns  into  money  or  its  equivalent.  If  he 
can  go  to  a  bank  and  make  a  showing  of  assets  to  that 
institution  such  as  to  convince  it  that  he  controls  goods 
or  property  to  the  amount  that  he  wants  to  borrow  plus 
an  ample  margin  of  safety  to  guard  against  depreciation, 
the  bank  will  usually  be  wdlling  to  take  his  ' '  note, ' '  which 
is  a  legal  lien  against  his  property,  and  to  give  him  in 
exchange  the  right  to  draw  upon  it,  agreeing  to  pay  at 
sight  the  obligations  that  may  be  presented  to  it  for 
cashing,  in  money. 

This  is  a  much  more  complicated  type  of  credit  trans- 
action, since  it  involves  not  merely  an  exchange  of  goods 
against  goods,  both  being  stated  in  terms  of  money,  or 
an  exchange  of  goods  against  the  personal  promise  of  an 


Modern  Banking  Functions  7 

individual  to  pay  at  some  time  in  the  future,  but  essen- 
tially an  exchange  of  credit  against  credit.  More  than 
90  per  cent  of  the  business  in  this  country  is  transacted 
on  a  credit  basis  and  payment  is  effected  through  a  great 
process  of  bookkeeping  between  individuals,  banks,  com- 
munities, and  nations.  The  convenience,  safety,  and 
economy  resulting  from  the  settling  of  commercial 
accounts  by  means  of  offsetting  credits  is  a  large  item 
in  commerce. 

The  classic  enumeration  of  banking  functions  describes 
them  as  those  of  'Miscount,"  ''deposit,"  and  "issue." 
By  "discount"  is  meant  substantially  what  the  average 
man  understands  by  loan.  By  "deposit"  is  meant  the 
acceptance  of  actual  funds  from  persons  who  leave  them 
with  the  bank,  or  the  crediting  on  the  books  of  the  bank 
of  specified  amounts  of  funds  for  which  the  "depositor" 
has  left  security  in  lieu  of  which  he  has  been  authorized  to 
draw  a  given  amount.  By  "issue"  is  meant  the  actual 
printing  and  paying  out  of  bank  notes,  which  are  pieces 
of  paper  authorizing  tlie  holder  to  demand  from  the  bank 
a  specified  amount  of  money.  As  a  matter  of  fact  all 
these  functions  are  really  parts  or  aspects  or  methods 
connected  with  a  single  function — the  extension  of  credit. 
In  the  further  study  of  these  different  banking  functions 
one  should  never  lose  sight  of  their  relations  to  the  cen- 
tral idea  of  a  bank  as  a  credit-extending  and  credit-guar- 
anteeing institution. 


TEST  QUESTIONS 

1.  From  what  two  points  of  view  may  banking  facilities  be 
considered  1 

2.  What  is  the  chief  economic  function  of  banks? 

3.  What  is  credit? 


8  American  Bunklny 

4.  How  does  a  bank  convert  the  credit  of  an  individual  into 
the  credit  of  a  bank? 

5.  From  the  standpoint  of  credit,  compare  an  open  charge 
account  of  a  merchant  with  an  account  for  which  a  note  has  been 
received. 

6.  Explain:  "More  than  90  per  cent  of  the  business  in  this 
country  is  transacted  on  a  credit  basis,  and  payment  is  effected 
through  a  great  process  of  bookkeeping  between  individuals, 
banks,  communities,  and  nations." 

7.  What  are  the  three  basic  functions  of  banks? 


CHAPTER  II 

CLASSES    OF    BANKS 

We  have  spoken  thus  far  as  if  the  ''bank"  were  a  uni- 
versal tjT)e  of  institution  belonging  to  a  single  homo- 
geneous class,  and  to  the  casual  observer,  perhaps,  banks 
do  not  differ.  They  all  seem  alike.  This  is  not  the  case. 
J^>anks  are  as  highly  specialized  and  as  highly  organized 
as  any  other  institutions  of  the  commercial  world.  Their 
classification  may  be  founded  upon  either  of  several  lines 
of  distinction.  A  clear  conception  of  the  several  classes 
of  banks  will  facilitate  greatly  an  understanding  of  the 
various  banking  functions  about  to  be  considered. 

The  bank  mav  be  in  the  habit  of  eVcending  credit,  or 
as  the  phrase  goes  "making  loan^,  ^  or  "lending  money," 
for  long  periods  or  shor^  r-riods.  On  the  basis  of  this 
distinction,  insti+-""oi^s  may  be  classified  as  commercial 
Y^o'-  ->i'^iiiercial  banks,  the  commercial  banks  "being 
those  which  engage  only  in  short-term  transactions  grow- 
ing out  of  industrial  and  commercial  business,  while  non- 
commercial banks  operate  chiefly  in  the  investment  field. 

Banks  may  confine  their  attention  to  a  particular  kind 
of  loans  or  to  loans  made  to  a  particular  class  of  bor- 
rowers. In  this  case  there  is  a  true  example  of  specializa- 
tion, often  for  the  sake  of  greater  efficiency  and  speed 
in  judging  certain  classes  of  paper.  Banks  may  be 
grouped  according  to  the  laws  under  which  they  are 
organized  and  the  functions  vrliich  they  are  allowed  to 
exercise  by  virtue  of  such  laws.     Sometimes  they  are 

9 


10  American  Banking 

classified  according  to  the  habits  they  adopt  with  refer- 
ence to  reserves  and  the  like.  A  good  many  other  modes 
of  classification  might  be  suggested,  but  there  are  only 
two  that  need  particular  attention  here.  These  two  are 
the  grouping  of  banks  according  to  their  legal  status  and 
the  grouping  according  to  their  economic  or  commercial 
or  financial  status. 

Legal  Status  of  Banking 

There  is  no  reason  why  the  business  of  banking  should 
not  be  undertaken  by  a  single  individual  acting  for  him- 
self, just  as  he  might  take  up  any  other  kind  of  business. 
Some  of  the  most  successful  bankers  in  history  have 
been  individuals  who  thus  conducted  operations  on  their 
own  responsibility  and  with  their  own  capital.  But  the 
great  importance  of  banking  in  modern  times  has  led 
to  the  passage  of  laws  under  which  the  creation  of  banks 
and  the  conduct  of  banking  is  very  carefully  supervised, 
while  the  large  capital  that  is  needed  in  the  business  and 
the  desirability  of  co-opei.v<:ion  in  carrying  the  enterprise 
on  have  made  it  advantageous  e^>.  several  persons  to 
unite.  The  result  of  this  has  been  that  m^.u,  i.cnks  today 
are  organized  either  (1)  under  special  charters  passeu  uy 
legislative  bodies  or  (2)  under  general  legislation  apply- 
ing to  banks  as  such.  Such  legislation  may  originate  with 
any  grade  of  government  which  is  competent  to  grant 
authority  for  incorporation. 

Banks  of  the  first  class  mentioned  are  best  exemplified 
by  the  great  chartered  institutions  of  Europe.  These 
institutions  operate  under  acts  granting  them  special 
powers  and  defining  what  their  functions  and  duties  are, 
as  well  as  the  extent  to  which  they  shall  be  subject  to 
control  by  the  state.  Some  of  them  are  allowed  monopo- 
lies of  various  banking  functions,  such  as  that  of  note 


Classes  of  Banks  11 

issue.  In  the  United  States,  banks  of  this  description 
were  created  under  the  laws  chartering  the  First  and 
Second  Banks  of  the  United  States  in  1791  and  1817 
respectively. 

The  second  class  of  banks,  organized  under  general 
legislation  permitting  any  group  of  persons  to  engage  in 
the  business  under  specified  conditions,  is  seen  in  the  case 
of  the  institutions  which  exist  today  in  the  United  States. 
The  national  banks  of  the  United  States  are  created 
under  an  act  of  Congress  known  as  the  National  Bank 
Act,  originally  passed  in  1863  and  later  modified,  which 
specifies  the  conditions  under  which  such  institutions 
may  be  organized  and  which  indicates  their  relationship 
to  the  federal  government  and  the  powers  of  control  to 
be  exercised  by  the  latter. 

Practically  every  state  in  the  Union  has  also  a  banking 
act  of  its  own  which  permits  the  organization  of  banks 
amenable  to  the  state  authority  and  to  no  other.  These 
are  known  as  ''state  banks." 

Beside  these  institutions,  there  have  been  organized 
in  the  several  states  others  that  do  a  true  banking  busi- 
ness although  they  occasionally  combine  it  with,  business 
of  other  descriptions.  Thus  in  many  states  are  found 
so-called  "loan  and  trust  companies"  organized  under 
laws  of  a  special  character.  "Savings  banks"  are  also 
found,  organized  either  as  stock  companies  or  as 
"mutual"  institutions.  Building  and  loan  associations 
organized  under  special  laws  exercise  certain  banking 
functions  of  a  particular  kind.  There  are  insurance  com- 
panies also  which  perform  some  functions  of  the  same 
sort,  and  banking  duties  have  occasionally  been  taken 
over  by  businesses  whose  principal  occupation  is  not  that 
of  banking  but  is  wholly  apart  from  it.  Instances  of  this 
sort  are  seen  in  the  department  stores  of  our  larger  cities, 


12  American  Banking 

some  of  which  have  established  '* banking  departments" 
for  the  sake  of  facilitating  the  credit  operations  of  their 
customers. 

National  Banks 

The  class  of  institutions  upon  which  the  interest  of  the 
student  of  banking  in  this  country  is  chiefly  concentrated 
is  that  chartered  by  the  federal  government  under  the 
National  Bank  Act.  A  more  complete  description  of  the 
working  of  this  system  will  be  afforded  somewhat  later. 
It  is  desired  at  this  point  merely  to  sketch  certain  salient 
aspects  of  it. 

The  national  banks  belong  essentially  to  the  typo  called 
''commercial  banks."  That  is  to  say,  their  operations 
are  limited  by  law  to  those  classes  of  transactions  that 
are  ob\"iously  short-term  in  character.  The  restrictions 
placed  upon  the  conchtions  under  which  the  national 
banks  may  lend  and  the  kinds  of  security  which  they  may 
accept,  if  rigidly  observed,  confine  the  banks  to  the  com- 
mercial business  of  lending  to  persons  who  have  live 
security  and  expect  to  pay  at  the  end  of  thirty,  sixty, 
ninety,  or  one  hundred  and  twenty  days. 

These  banks,  owing  to  the  provisions  of  the  law  under 
which  they  are  organized,  also  represent  the  cash  reserve 
or  money  reserve  of  the  country,  since  they  are  required 
to  maintain  a  specified  percentage  of  their  liabilities  in 
the  form  of  legal-tender  money.  They  also  have  a  special 
relation  to  the  government  in  that  they  are  examined  by 
federal  examiners  and  report  regularly  to  an  official 
called  the  comptroller  of  the  currency  whose  office  is  a 
bureau  in  the  Treasury  Department  at  Washington. 
Moreover  these  banks  issue  notes  and,  owing  to  legisla- 
tion designed  for  that  purpose,  state  banks  are  prac- 
tically prevented  from  performing  this  function.     The 


Classes  of  Banks  13 

national  banks,  too,  receive  government  funds  on  deposit 
under  specified  conditions  and  thus  occupy  an  official 
relation  to  the  Treasury  Department. 

The  federal  reserve  banks  are  banks  created  by  the 
joint  contributions  of  other  banks  and  are  practically 
co-operative  unions  designed  to  make  these  other  banks 
more  effective  in  their  operations.  The  subject  is  treated 
further  in  later  chapters. 

State  Banks 

The  state  banks  are  organized  under  state  laws,  gen- 
erally in  the  way  already  pointed  out.  Such  state  laAvs 
are  occasionally  more  or  less  close  reproductions  of  the 
National  Bank  Act.  In  a  good  many  states,  how^ever, 
the  banking  laws  permit  greater  latitude  to  the  banks 
organized  under  them  in  the  matter  of  classes  of  business 
accepted,  amount  of  reserves  maintained,  conditions  of 
security  to  depositors,  and  the  like.  In  some  states,  the 
examinations  carried  on  by  state  bank  examiners  are 
lax  and  the  banks  are  allowed  to  do  very  much  as  they 
please. 

The  best  state  banks  compare  favorably  with  the  best 
national  banks  and,  barring  the  issue  of  notes,  they  do 
very  much  the  same  kind  of  work,  discount  very  much 
the  same  kind  of  paper,  carry  on  their  business  in  very 
much  the  same  way,  and  are  equally  reliable. 

The  weaker  state  banks,  organized  in  states  w^here 
public  supervision  is  at  a  low  ebb,  make  loans  upon  less 
satisfactory  security,  and  for  longer  periods,  engage  in 
classes  of  business  that  are  not  exactly  within  the  prov- 
ince of  banking  in  the  best  sense  of  the  word,  and  in 
general  represent  a  lower  and  less  responsible  type  of 
institution  than  do  the  national  banks.  This  does  not 
necessarily  mean  that  such  banks  are  irregularly  car- 


14  American  Banking 

ried  on,  but  simply  that  their  operations  are  not  confined 
to  the  classes  of  business  which  we  have  already  grouped 
as  ''banking"  in  the  strict  sense  of  the  term,  while  the 
hazards  and  risks  they  incur  are  such  as  occasionally  to 
give  rise  to  well-grounded  fears  concerning  their  stability 
and  solvency.  They  may,  and  sometimes  do,  perform  a 
useful  service  in  communities  where  national  banks 
would  find  themselves  very  seriously  limited  and  crip- 
pled in  the  classes  of  business  they  could  accept  and  yet 
keep  within  the  provisions  of  the  banking  law. 

Pkivate  Banks 

Private  banks  are  unincorporated  institutions  that 
transact  the  regular  banking  business  of  deposit  and 
discount.  Two  types  of  these  institutions  should  be  dis- 
tinguished. Private  banking  firms  such  as  that  of  J.  P. 
Morgan  &  Co.  are  large  financial  houses  engaged  in 
promoting  and  financing  enterprises,  underwriting  their 
securities,  selling  railroad  and  industrial  bonds,  making 
loans  to  city,  state,  and  national  governments,  and  trans- 
acting other  important  financial  business.  They  usually 
receive  deposits  and  may  or  may  not  discount  commer- 
cial paper. 

The  other  type  of  private  bank  is  a  survival  of  pioneer 
conditions.  An  individual  or  group  of  individuals  simply 
open  a  banking  business  very  much  as  they  would  open 
a  grocery  store.  They  then  solicit  deposits  and  make 
loans  and  conduct  a  general  banking  business,  either  by 
itself  or  in  conjunction  with  some  other  business — real 
estate,  insurance,  or  something  else.  No  specific  amount 
of  paid-up  capital  or  resources  is  required,  and  other 
canons  of  banking  safety  are  not  always  observed.  In 
large  cities,  especially,  people  of  foreign  descent  have 
often  been  deceived  by  men  of  their  own  nationality  who 


Classes  of  Banks  15 

have  opened  such  banks,  accepted  deposits,  and  even- 
tually absconded.  The  abuse  of  this  system  by  unscrupu- 
lous enterprises  has  led  many  states  to  prohibit  private 
banking  altogether,  and  in  other  states  such  banks  are 
placed  under  the  same  regulations  and  supervisions  as 
incorporated  banks. 

Loan  and  Trust  Companies 

In  the  loan  and  trust  companies,  we  have  a  type  of 
institutions  which  are  really  supplementary  to  the  bank 
as  such.  Organized  under  special  laws,  trust  companies 
perform  a  number  of  operations  which  are  not  exactly 
banking,  but  are  closely  allied  thereto.  As  their  name 
implies,  they  are  largely  concerned  with  operations 
involving  ' '  trusts. ' '  That  is  to  say,  they  act  in  a  fiduciary 
capacity.  They  not  only  take  care  of  securities  and  val- 
uables, usually  having  ample  and  well-appointed  vaults 
for  this  purpose,  but  execute  individual  trusts,  act  as 
executors,  sometimes  furnish  life,  title,  and  fidelity  insur- 
ance, and  do  other  things  of  the  same  nature.  An  impor- 
tant function  in  modern  commercial  life  is  that  of  trus- 
teeship under  corporate  mortgages.  Trust  companies  act 
as  mortgagees  in  trust  for  bondholders,  register  bonds, 
collect  the  interest,  pay  the  bonds  at  maturity,  and  take 
the  necessary  legal  steps  for  protection  of  the  bond- 
holders in  case  of  default. 

In  the  course  of  these  operations,  such  institutions  are 
likely  to  have  a  good  deal  of  ready  cash  on  hand.  There- 
fore, instead  of  depositing  their  investment  funds  in 
banks,  most  trust  companies  now  carry  on  a  banking 
department  and  receive  deposits,  make  loans,  and  do 
other  banking  duties.  In  such  cases,  the  separate  depart- 
ments are  of  course  organized  in  order  to  take  care  of 
the  different  classes  of  business.    It  sometimes  happens 


16  American  Banking 

that  a  trust  company  is  primarily  a  bank,  its  otlier  func- 
tions sinking  into  the  background,  while  in  some  instances 
the  banking  duties  are  purely  incidental  to  the  others. 

As  a  rule,  the  trust  companies  of  the  United  States  do 
not  endeavor  to  keep  large  reserves  of  coin  or  currency, 
but  deposit  the  bulk  of  their  reserves  with  banks,  either 
state  or  national,  expecting  these  institutions  to  supply 
them  with  money  when  it  is  needed. 

The  advantages  of  the  trust  company  are  those  which 
come  from  the  combination  of  banking  with  trusteeship 
and  the  allied  occupations,  and  the  fact  that  the  trust 
company  is  not  hampered  by  the  close  restrictions  which 
hedge  about  the  banks  and  can  therefore  loan  on  long- 
period  inactive  security.  The  disadvantages  of  the  trust 
company  are  found  in  the  fact  that  it  is  not,  and  does  not 
pretend  to  be,  a  commercial  bank,  while  nevertheless  the 
public,  seeing  it  performing  the  superficial  functions  of 
banking,  expects  it  to  live  up  to  the  obligations  of  the 
bank  in  the  matter  of  reserves,  prompt  payment,  Cjuick- 
ness  of  assets,  and  the  like.  The  trust  company,  however, 
is  not  a  bank  although  it  exercises  banking  functions. 

Savings  Banks 

In  the  case  of  the  savings  banks  a  still  further  varia- 
tion is  to  be  noted.  The  savings  bank  is  what  its  name 
implies — a  bank  for  savings.  It  seeks  to  collect  small 
sums  from  persons  who  have  accumulated  them  and  then 
to  use  these  funds  in  such  a  way  as  to  make  the  greatest 
return  consistent  with  safety.  It  emphasizes  safety  and 
fair  interest  returns  as  against  ease  of  liquidation. 

No  genuine  commercial  bank  should  allow  interest  on 
deposits,  although  there  are  such  banks  which  make  a 
practice  of  granting  interest  on  certain  conditions.  The 
trust  company  usually  allows  some  interest  on  deposits. 


Classes  of  Banks  17 

and  the  primary  purpose  of  the  savings  bank  is  not  only 
the  accnmulation  of  savings  and  their  safe-keeping  but 
the  earning  of  interest  tliereon.  In  other  words,  while 
the  commercial  bank  is  primarily  organized  for  the  pur- 
pose of  maldng  extensions  of  credit,  and  while  the  trust 
company  in  its  banking  function  does  the  same,  the  sav- 
ings bank  endeavors  to  induce  persons  with  small  means 
to  leave  their  funds  with  it  to  earn  interest.  The  bank 
seeks  to  make  a  profit  not  by  the  extension  of  credit  on 
short-time  commercial  security  of  the  quickest  or  most 
salable  character  but  usually  by  long-term  loans,  based 
perhaps  on  real  estate,  or  through  the  purchase  of  very 
high-grade  bonds  or  other  securities  yielding  a  fair 
interest. 

The  savings  bank  may, be  organized  as  a  stock  company 
like  any  other  bank,  in  which  case  it  allows  interest  to 
the  depositors,  invests  the  funds  left  with  it  to  the  best 
of  its  ability,  and  gives  such  surplus  as  there  may  be  to  its 
stockholders.  Or  the  savings  bank  may  be  organized 
on  a  mutual  principle  under  which  every  depositor 
becomes  a  sharer  in  the  profits  of  the  institution  in  pro- 
portion to  the  amount  of  the  funds  he  has  left  with  it. 
He  is  granted  a  rate  of  interest  on  his  deposits  which  is 
fixed  by  a  consideration  of  the  net  earnings  of  the  insti- 
tution after  expenses  of  management,  etc.,  have  been 
taken  out  and  necessary  contingencies  provided  for.  The 
savings  bank,  like  the  trust  company,  is  likely  to  keep 
most  of  its  spare  funds  on  deposit  with  a  commercial 
bank,  which  may  or  may  not  allow  it  a  small  rate  of 
interest  thereon. 

Building  Loan  Associations 

The  building  loan  association  is  an  institution  of  a 
special  type  which  cannot  be  regarded  as  a  bank  but 


18  American  Banking 

which  plays  a  certain  part  in  the  financial  organization 
of  the  country  and  should  therefore  be  noted.  Its  pur- 
pose is  somewhat  similar  to  that  of  the  savings  bank.  It 
confines  its  loans,  however,  chiefly  to  real  estate,  and 
extends  credit  to  individuals  who  want  to  erect  homes 
or  other  buildings,  paying  for  them  gradually  and  in  the 
meantime  giving  a  lien  on  the  property.  Such'associa- 
tions,  also,  frequently  make  loans  upon  buildings  which 
have  already  been  erected,  in  order  to  accommodate  the 
owners.  Some  associations  aim  to  confine  their  loans  to 
persons  who  are  members  of  the  association,  while  others 
do  not  require  membership  but  are  really  institutions  for 
loaning  on  real  estate.  Some  of  the  associations  obtain 
their  funds  gradually  at  so  much  per  week  or  per  month 
through  the  steady  payment  of  specified  sums  by  wage- 
earners  who  expect  to  receive  loans  for  the  purpose  of 
erecting  homes.  While  these  savers  are  putting  in  their 
cash  it  is  being  used  in  loans  to  others,  the  security  being 
the  buildings  erected  by  the  latter.  In  this  aspect,  the 
building  loan  association  is  performing  a  function  which 
approximates  to  banking. 

Building  loan  associations  usually  keep  their  funds 
on  deposit  in  banks  when  not  in  use,  and  may  thus  become 
a  more  or  less  important  class  of  depositors  at  banks, 
representing  as  they  do  the  combined  means  of  many 
small  savers.  They  may  also  obtain  loans  at  banks  on 
the  strength  of  the  securities  they  have,  and  thus  they 
may  become  more  or  less  important  borrowers  or  clients 
of  banks. 

Insueance  Companies 

Originally,  the  insurance  company  was  just  what  its 
name  implies.  It  was  organized  for  the  purpose  of  car- 
rying risks  whether  on  human  life,  or  on  destructible 


Classes  of  Banks  19 

buildings  and  other  property,  or  on  titles.  As  the  insur- 
ance company  developed,  however,  it  became  an  impor- 
tant agency  for  saving  and  investing  funds.  Many 
persons  who  take  out  life  insurance  policies  do  so  not 
exclusively  for  the  protection  they  are  afforded  but 
largely  because  they  are  guaranteed,  or  expect,  a  certain 
return  at  the  end  of  a  stated  period — say  twenty  years. 
They  thus  find  the  insurance  policy  a  convenient  means 
of  laying  aside  some  sa\nngs  which  might  otherwise  go 
into  immediate  consumption.  In  the  case  of  so-called 
''endo^vment  policies"  the  saving  may  be  considerably 
more  prominent  than  the  insurance  feature. 

The  insurance  company  takes  the  premiums  paid  in 
on  the  policies,  promises  to  pay  a  given  amount  in  case 
of  death,  and  undertakes  to  return  at  the  end  of  a  stated 
period  a  specified  amount  dependent  perhaps  upon  its 
earnings  in  the  meanwhile.  It  then  undertakes  to  invest 
the  savings  that  have  been  poured  into  its  treasury.  In 
doing  so,  insurance  companies  have  of  recent  years 
become  very  large  investors  and  at  times  usurp  some 
banking  functions.  They  become  large  purchasers  of 
commercial  paper,  they  deposit  largely  in  commercial 
banks,  and  they  buy  largely  of  stocks,  bonds,  and  other 
securities  or  lend  largely  upon  them  as  collateral. 

Insurance  companies  in  the  employment  of  their  funds, 
therefore,  take  from  the  banks  some  of  the  business  the 
latter  would  otherwise  do,  and  at  times  stand  to  the 
borrower  in  very  much  the  same  relation  as  does  the 
bank.  This  may  be  true  as  the  result  of  a  direct  banking 
relationship  or  it  may  be  brought  about  through  the 
intermediation  of  a  trust  company  or  other  concern, 
probably  largely  controlled  by  the  insurance  company; 
but  the  result  is  the  same  in  one  case  as  in  the  other,  and 
in  this  aspect  the  insurance  company  must  be  regarded 


20  American  Banking 

as  a  factor  of  importance  in  the  study  of  the  banking 
situation  of  the  present  day. 

National  Banking  Systems 

In  practically  all  countries  it  has  been  found  that 
united  action  on  the  part  of  banks  was  from  time  to  time 
needful  for  reasons  later  to  be  considered,  and  this  fact 
has  led  to  the  organization  in  a  more  or  less  formal  way 
of  the  banks  of  the  several  nations  in  some  systematic 
manner.  Looked  at  from  this  general  point  of  view  the 
banking  systems  of  the  world  may  be  generally  divigled 
into  three  classes : 

1.  The  central  banking  systems,  so-called,  of  which 
the  French  system  may  be  taken  as  a  fair  example.  In 
these  a  central  banking  institution  acts  as  the  holder  of 
reserve  funds  and  usually  as  the  sole  issuer  of  notes  for 
a  nation.  Such  a  central  institution  may  have  a  good 
many  branches  or  it  may  not.  In  either  case  it  usually 
deals  chiefly  with  other  banks,  leaving  to  these  banks  the 
business  with  individual  customers.  This  latter  point  is 
not  a  universal  characteristic,  as  seen  in  the  case  of  the 
Bank  of  France,  whicli  loans  to  individuals  in  very  small 
amounts.  Whether  it  does  its  work  through  direct  loans 
to  individuals  or  through  intermediation  of  other  banks, 
however,  central  banks  of  the  kind  already  spoken  of, 
directly  influence  the  market  and  practically  control  rates 
of  interest. 

2.  The  independent  charter  banking  systems.  Of 
these  the  Canadian  is  the  principal  example.  The 
Canadian  banks  number  about  twenty-seven,  and  are 
nominally  free  competitors  with  one  another,  doing  their 
work  through  the  establishment  of  gTeat  networks  of 
branches,  interlacing  throughout  the  community.  Each 
of  these  institutions  has  the  note-issue  function  and  is 


Classes  of  Bauks  21 

essentially  a  central  bank  in  the  sense  that  it  controls  a 
large  reserve,  issues  paper  currency,  and  is  in  position 
to  shift  capital  from  one  part  of  the  country  to  another. 
An  added  element  of  strength  in  the  Canadian  system  is 
afforded  by  the  fact  that  a  joint  guaranty  fund,  applying 
to  the  notes  of  all  insolvent  Canadian  banks,  is  estab- 
lished. 

3.  The  independent  competitive  hanking  systems,  of 
which  the  American  system  is  the  principal.  In  the 
American  banking  system  individual  institutions  have 
been  chartered,  as  already  noted,  both  by  the  United 
States  and  by  the  several  States,  subject  merely  to  some 
general  requirements.  Under  this  plan  practically  any- 
one could  organize  a  bank  if  he  had  the  necessary  capital. 

TEST  QUESTIONS 

1.  Distinguish  between  commercial  banks  and  non-commer- 
cial banlcs.  Can  you  give  the  name  of  at  least  one  institution 
in  each  class? 

2.  In  what  different  ways  do  banks  specialize  for  the  pur- 
pose of  rendering  efficient  service  to  their  customers? 

3.  Under  what  two  legal  plans  are  most  banks  organized 
today?    "What  system  prevails  in  your  own  state? 

4.  "Why  are  national  banks  essentially  "commercial  banks"? 

5.  What  are  the  two  types  of  private  banks?  Do  private 
banks  exist  in  your  state? 

6.  How  does  a  private  bank  differ  from  a  state  bank? 

7.  "What  are  the  essential  features  of  loan  and  trust  com- 
panies ? 

8.  Why  should  insurance  companies  be  considered  in  a  dis- 
cussion of  banking  problems? 

9.  What  are  the  three  chief  types  of  national  banking 
systems  ? 

10.  What  are  the  distinguishing  characteristics  of  each 
system  ? 


CHAPTER  III 

THE    BANK   LOAN 

The  making  of  a  bank  loan  may  be  best  understood  by 
supposing  the  case  of  a  borrower  who  presents  himself 
at  a  bank.  His  application  for  a  loan  having  been  favor- 
ably acted  upon,  he  may  be  allowed  the  amount  he  desires 
in  any  one  of  several  forms: 

1.  A  credit  of  the  given  amount  may  be  allowed  him 
upon  the  books  of  the  bank. 

2.  His  loan  may  be  given  him  in  bank  notes. 

3.  He  may  be  given  the  amount  in  legal  tender  money 
or  currency. 

In  practice,  the  form  of  loan  actually  adopted  will  be 
one  of  the  first  two.  That,  however,  need  not  detain  us 
here.  Supposing  that  the  first  form  is  adopted,  the  next 
step  is  to  give  to  the  bank  some  evidence  that  such  a  loan 
has  been  made  and  that  the  borrower  is  under  obligation 
to  return  it  at  a  fixed  date,  and  to  the  borrower  a  state- 
ment that  he  has  been  granted  such  a  loan  and  is 
authorized  to  draw  upon  the  institution  for  the  amount 
allowed  him. 

The  borrower,  under  such  conditions,  will  hand  to  the 
banker  a  form  of  ''note"  evidencing  his  obligation  to 
pay.  The  banker  will  hand  to  the  borrower  a  "pass 
book"  with  the  amount  of  the  loan,  written  in  figures 
upon  the  appropriate  page,  to  the  borrower's  credit.  A 
like  entry  having  been  made  upon  the  books  of  the  bank, 
the  transaction  is  consummated,  and  the  borrow^er  is  at 

22 


The  Bank  Loan  23 

liberty  to  use  the  amount  thus  credited  to  him  as  he 
sees  fit.  He  may  thereupon  draw  it  out  in  cash  or  sim- 
ply transfer  to  another  his  right  to  draw  upon  the  bank 
for  the  specified  amount.  An  order  of  transfer  of  this 
sort  is  called  a  ''check."  In  either  case,  the  credit  thus 
granted  serves  the  purpose  of  the  borrower  by  enabling 
him  to  liquidate  indebtedness  falling  due  at  once. 

More  Complex  Transactions 

Such  simple  forms  of  transaction  occur  comparatively 
seldom  in  actual  practice.  The  bank  does  not  always 
lend  directly  to  a  borrower  who  comes  for  a  personal 
loan.  Nor  does  it  usually  lend  its  credit  with  nothing 
except  the  general  assurance  that  the  borrower  will 
return  the  amount.  That  type  of  transaction  may  suffice 
in  cases  where  the  borrower  is  exceptionally  well  known 
to  the  bank,  or  where  his  standing  and  solvency  are  above 
all  question.  But  in  the  majority  of  cases  such  assur- 
ance cannot  be  felt,  or,  if  it  is,  the  banker  does  not  care 
to  hazard  the  property  of  the  stockholders  in  his  insti- 
tution merely  because  he  personally  feels  assured  of  the 
ability  and  intent  of  the  borrower  to  pay  at  the  time 
when  the  loan  falls  due.  Consequently,  there  is  usually 
a  demand  for  some  further  assurance  to  the  bank  that 
the  borrower  will  liquidate  when  the  time  comes. 

Such  assurance  may  be  gained  in  one  of  two  ways : 
(1)  the  borrower  may  associate  with  himself  another 
signer  to  the  paper  or  ' '  note, ' '  thus  giving  the  weight  of 
two  names  to  the  paper;  or  (2)  he  may  give  the  bank 
title  to  some  piece  of  property  of  known  value,  thereby 
assuring  it  of  the  possibility  of  recovering  its  funds  by 
sale  of  the  property  in  the  event  of  failure  on  the  part  of 
the  borrower  to  redeem  his  promise — or,  what  is  more 
to  the  purpose,  assuring  the  bank  itself  of  the  borrower's 


24  American  Banking 

true  purpose  to  redeem  at  the  time  set  because  of  his 
loss,  otherwise,  of  the  property.  AYhich  of  these  modes 
of  ''securing"  the  loan  will  be  employed  in  a  given  case 
will  depend  upon  circumstances  which  it  is  now  our  pur- 
pose to  detail. 

The  "Discount" 

The  personal  tj^pe  of  security  which  consists  of  a  note 
backed  by  two  or  more  names  may  be  created  in  one  of 
two  ways.  A  may  ask  for  a  loan  at  a  bank  and  be  refused 
in  default  of  an  indorser.  He  may  go  to  B  and  ask  the 
latter  to  join  in  supporting  the  note.  This  can  be  done 
by  B's  "indorsing"  the  note,  an  operation  which  con- 
sists in  his  placing  his  signature  on  the  back  of  the 
instrument.  In  that  event,  B  becomes  liable  for  the 
amount  of  the  note,  should  A  refuse  to  pay  it,  and  the 
bank  may  institute  legal  proceedings  for  the  purpose  of 
recovering  from  B  should  such  action  become  desirable. 
The  same  would  be  true  of  other  indorsers,  if  more  than 
one  were  induced  to  attach  his  signature  to  a  note.  This 
tjToe  of  commercial  paper  is  often  designated  as  accom- 
modation paper.  There  is  no  certain  way  of  knowing 
from  the  face  of  the  note  whether  it  represents  a  con- 
cluded transaction  or  an  intended  one. 

Of  more  importance  than  such  transactions  is  a  second 
mode  of  securing  two  signatures.  A  may  have  bought 
goods  from  B,  and  not  being  able  to  pay  in  cash  or  bank 
checks  for  them,  he  may  give  B  his  own  note  for  the 
amount.  B,  desiring  immediate  funds,  may  take  this 
note  to  a  bank  and  ask  for  a  loan  on  the  strength  of  it. 
The  banker  will  then,  if  B's  credit  at  the  institution  is 
satisfactory,  or  if  the  original  maker  of  the  note  is  known 
to  him,  take  the  note  with  the  indorsement  of  B,  and  place 
the  value  of  the  paper  to  the  credit  of  B. 


The  Banl-  Loan  25 

111  such  a  case,  the  operation  is  said  to  be  a  *'disconnt" 
and  the  note  is  said  to  have  been  ''discounted."  The 
amount  set  to  the  credit  of  B  is  the  face  of  the  note  less 
the  interest  on  the  sum  for  the  life  of  the  note  and  tlie 
difference  or  interest  is  called  the  discount.  Discount 
is  interest  deducted  in  advance.  If  the  sum  is  paid  at 
maturity  it  is  interest.    The  essence  is  the  same. 

Much  of  the  bank  paper  of  the  present  day  is  of  this 
t}ipe,  for  in  practice  a  large  volume  of  goods  is  sold  upon 
credit,  while  in  order  to  get  immediate  funds  the  sellers 
of  such  goods  demand  and  receive  from  their  customers 
"paper"  which  can  be  discounted.  The  discounting  of 
commercial  paper  is  a  link  in  the  commercial  practice  of 
buying  and  selling  on  time.  It  enables  a  debtor  to  pay 
his  debts  as  they  fall  due  by  realizing  upon  the  amounts 
due  him  from  other  people. 

Another  Form  of  the  Transaction 

It  is  not  necessary  that  the  discount  should  be  managed 
in  the  way,  or  assume  precisely  the  form,  that  has  just 
been  indicated.  Usually  the  paper  which  is  created  by 
buyers  of  goods  and  is  by  them  transferred  to  sellers  in 
order  to  enable  the  latter  to  get  credit  at  their  banks  will 
be  drafts  or  bills.  That  is  to  say,  a  sale  of  goods  may  be 
made  ^vithout  the  signature  of  the  buyer  upon  a  "note." 
The  buyer  may  give  the  seller  the  privilege  to  "draw" 
upon  him  at,  say,  sixty  days.  In  that  event,  a  "draft"  is 
dra\m  by  the  seller  of  the  goods.  This  is  merely  an  order 
to  the  buyer  to  pay  to  a  designated  person  or  bank  a 
specified  sum  after  the  lapse  of  the  period  for  which  the 
goods  were  sold.  When  this  draft  is  signed  by  the 
drawer  of  the  draft,  it  is  sent  through  a  bank  to  the 
buyer  of  the  goods,  who  is  then  called  the  ' '  drawee. ' '  If 
he  writes  the  word  "Accepted"  across  the  face  of  the 


26  American  Banking 

paper  with  his  signature,  the  draft  becomes  a  legal  obli- 
gation against  him  on  the  date  at  which  it  falls  due,  and 
the  bank  is  able  to  give  a  credit  of  corresponding  amount 
to  the  person  who  sold  the  goods  and  subsequently  drew 
the  draft.  It,  of  course,  deducts  the  discount  or  interest 
for  the  period  for  which  the  funds  were  advanced  (i,  e., 
the  period  intervening  between  the  drawing  of  the  draft 
and  its  payment). 

The  bank  then  places  the  draft  in  its  ''portfolio" — that 
is  to  say,  adds  it  to  its  stock  of  assets,  and  when  the  date 
of  maturity  arrives,  it  presents  it  to  the  drawee  who 
originally  bought  the  goods.  If  he  pays,  there  is  an 
end  to  the  transaction.  If  he  refuses  to  pay,  the  bank 
falls  back  upon  the  man  who  originally  secured  the  dis- 
count and  he  is  compelled  to  make  the  amount  good. 
In  these  transactions  the  bank  is  careful  to  observe  the 
provisions  of  law,  especially  the  Negotiable  Instruments 
Law,  regarding  notice  of  dishonor  and  protest. 

Collateral  Loans 

The  collateral  loan  is  similar  in  principle  to  the 
indorsed  note  or  draft  but  differs  in  form.  It  is  evident 
that  an  individual  who  is  borromng  funds  for  his  imme- 
diate use — without  reference  to  sales  of  goods — may 
prefer  not  to  ask  others  to  become  joint  security  with 
him.  He  may  have  no  claim  upon  other  individuals  that 
would  entitle  him  to  request  such  a  service,  or  he  may  not 
wish  to  have  the  nature  of  his  accommodations  at  banks 
generally  understood.  It  may,  for  either  of  these  rea- 
sons, be  desirable  for  him  to  secure  his  accommodation 
solely  on  his  o^vn  responsibility.  This  is  readily  accom- 
plished, if  he  has  negotiable  securities  in  his  control. 
Such  securities  may  be  notes  of  others  secured  by  mort- 
gages or  otherwise  or  they  may  be  stocks  or  bonds  issued 


I 


The  Bank  Loan  27 

by  corporations  and  of  known  value.  In  other  cases, 
additional  kinds  of  collateral  security  may  be  employed, 
such  as  warehouse  receipts  and  bills  of  lading.  The  com- 
monest form,  however,  is  the  stock  or  bond. 

Going  with  such  securities  to  the  bank,  the  borrower 
is  accorded  a  credit  proportioned  to  the  amount  and 
value  of  the  securities  he  presents.  Such  a  loan  is  pro- 
tected by  his  leaving  with  the  bank  the  actual  securities 
or  values  on  which  he  depends  for  making  the  loan  good, 
accompanied  by  an  assignment,  a  form  of  authorization 
signed  by  the  borrower  and  permitting  the  bank  to  sell 
the  securities  in  the  event  that  he  fails  to  perform  the 
obligations  mentioned  in  his  note. 

Call  Loans 

In  most  cases,  with  commercial  banks,  such  collateral 
notes  are  not  for  definite  times — as  thirty,  sixty,  or 
ninety  days — but  are  made  ' '  on  call ' ' — that  is,  they  may 
be  called  in  for  pajmient  by  the  bank  whenever  it  desires. 
Often,  such  a  call  is  preceded  by  a  demand  for  more 
security  and  in  the  event  that  it  is  not  furnished,  the 
borrower  is  requested  to  pay  his  obligation.  In  case  he 
refuses  or  fails  to  make  such  pajTuent,  his  securities  are 
sold,  the  bank  is  reimbursed,  and  the  balance,  if  any, 
is  credited  to  the  borrower. 

Special  Collateral  Loans 

Special  collateral  loans  are  frequently  made  for  the 
purpose  of  financing  a  special  type  of  transaction.  An 
individual  may  wish  to  buy  largely  of  a  given  kind  of 
security  on  the  market  because  he  believes  its  value  will 
rise  or  for  some  other  reason.  In  such  a  case,  he  may 
find  that  his  means  are  insufficient  to  enable  him  to  make 
the  purchases  he  desires,  and  he  may  negotiate  a  loan 


28  American  Banking 

from  a  bank  for  the  purpose  of  completing  the  transac- 
tion. In  that  event  he  pays  in  his  oa\ti  funds  as  far  as 
they  will  go,  and  then  draws  upon  the  bank  for  the  addi- 
tional amount  needed  to  carry  out  the  bargain. 

The  bank  is  thus  practically  joining  "\^atli  the  buyer 
of  the  securities  in  the  purchase.  It  is  permittmg  him 
to  use  its  funds  for  making  his  purchases  up  to  a  certain 
percentage  of  the  value  of  the  security.  The  funds  of  the 
buyer  are  invested  in  the  security  additionally,  and  con- 
stitute a  ''margin"  of  safety  to  the  bank,  which  is 
supposed  to  be  as  large  as  the  fluctuations  in  the  worth  of 
the  stock  or  bonds  will  be  under  any  probable  circum- 
stances. The  buyer  assumes  all  risk  in  one  view  of  the 
case,  while  the  bank  supplies  the  indisputable  value  of 
the  security.  It  has  the  advantage  of  placing  its  funds 
at  interest  while  the  borrower  presumably  protects  it 
against  loss  due  to  fluctuations  in  values,  and  it  is  able 
to  call  in  the  loan  at  any  time  when  the  funds  are  needed 
in  other  directions.  This  works  well  as  long  as  the 
suppositions  on  which  it  is  founded  remain  true ;  i.  e.,  as 
long  as  the  security  has  a  marketable  value  which  is 
higher  than  the  amount  of  the  loan.  Under  special  cir- 
cumstances this  may  not  be  the  case,  and  in  such  an  event 
the  bank  finds  its  funds  ''tied  up,"  since,  o^^ing  to  tem- 
porarily unfavorable  conditions,  it  cannot  sell  out  the 
stocks  or  bonds  at  a  value  which  will  reimburse  it. 

The  same  sort  of  loan  may  be  secured  upon  goods 
stored  in  elevators  or  warehouses.  The  warehouse 
receipt  is  then  attached  to  the  bill  of  exchange. 

DocuMEXTED  Bills  of  Exchange 

A  type  of  bank  loan  which  combines  some  features  of 
the  collateral  loan  and  of  the  personally  secured  type, 
is  seen  when  credit  is  granted  upon  bills  of  exchange 


I 


The  Bank  Loan  29 

secured  by  evidences  that  goods  are  in  transit  from  one 
point  to  another.  This  type  of  loan,  evidenced  by  what 
is  known  as  a  "documented  bill  of  exchange,"  is  espe- 
cially common  in  connection  with  the  operation  Avhich  is 
known  as  "moving  the  crops,"  though  there  is  a  tendency 
to  eneourag-e  its  use  in  all  commercial  transactions. 

The  character  of  the  business  which  produces  a  trans- 
action of  this  kind  maybe  understood  from  a  brief  outline 
of  the  circumstances.  A,  a  cotton  broker  in  Savannah, 
Ga.,  has  consigned  cotton  of  a  given  quality  to  some  mills 
at  Fall  River,  Mass.,  owned  by  B.  He  turns  the  cotton 
over  to  the  railroad  company  consigned  to  B  and 
receives  from  the  railroad  company  a  duplicate  bill  of 
lading  which  constitutes  his  receipt  for  the  goods.  It 
may  be  ten  days  or  two  weeks  before  the  cotton  is  deliv- 
ered to  the  buyer,  B.  A  takes  the  bill  of  lading  and 
attaches  it  to  a  draft  or  "sight  bill"  drawn  upon  B.  He 
discounts  this  draft  at  his  bank  and  the  bank  transmits 
it  to  a  correspondent  bank  in  Fall  River  which  presents 
it  to  B  for  payment  when  the  cotton  is  received.  The  bill 
of  lading  is  not  released  by  the  bank  until  arrangements 
have  been  made  by  the  consignee  for  paying  the  draft. 
A  thus  gets  the  advantage  of  the  funds  immediately, 
while  the  banks  get  the  discount  for  ten  days  or  two 
weeks  as  the  case  may  be. 

Documented  Bills  ix  Foreign  Trade 

Documented  bills  of  exchange  are  used  extensively  in 
international  trade,  and  in  such  trade  the  "documents" 
needed  for  the  complete  protection  of  the  draft  become 
much  more  numerous.  Such  documents  include  not  only 
the  bill  of  lading  but  also  certificates  of  marine  insur- 
ance, consular  invoices,  certificates  of  origin,  and  all 
other  papers  that  are  necessary  to  enable  the  goods  to 


30  American  Banking 

pass  rapidly  through  the  formalities  connected  with  the 
custom-house  administration  in  the  countries  to  which 
the  articles  are  sent. 

In  such  foreign  trade  operations,  the  banks  which  han- 
dle the  loan  are  enabled  to  make  an  additional  profit, 
apart  from  the  discount  charged  by  them,  inasmuch  as 
they  are  also  performing  a  foreign  exchange  transaction, 
in  which  the  currency  of  one  country  is  exchanged  for 
that  of  another.  Thus,  if  A  in  New  York  has  sold  a  bill 
of  goods  to  B  in  Hamburg,  Germany,  and  discounts  his 
claim  upon  B  at  a  New  York  bank,  the  bank  gives  him 
credit  in  American  dollars  while  the  claim  will  be  col- 
lected of  B  in  Hamburg,  through  a  Hamburg  bank  in 
German  money,  at  an  agreed-upon  equivalence.  This 
complicates  the  transaction  to  some  extent  and  involves 
various  modifications  of  the  operation  which  may  be 
better  dealt  with  in  comiection  with  what  we  shall  have 
to  say  of  foreign  exchange. 

The  security  of  the  bank  which  discounts  documented 
bills  resides  first  of  all  in  the  fact  that  it  is  a  party  to  a 
transaction  in  which  valuable  goods,  usually  of  staple 
quality  and  consequently  of  known  market  value,  are 
passing,  and  that  it  has  the  title  to  such  goods  in  its  pos- 
session. Obviously  the  persons  who  are  conducting  such  a 
transaction,  if  it  is  bona  fide,  would  not  engage  in  it  unless 
the  goods  were  valued  by  the  buyer  and  seller  at  the  rate 
agreed  upon.  No  doubt  there  might  be  a  collusive 
arrangement  between  buyer  and  seller  in  which  the  goods 
said  to  have  been  shipped  were  not  as  represented  or 
were  not  valued  as  highly  as  represented.  The  former 
question — the  reality  of  the  goods — is  really  tested  by 
the  railroad  or  other  carrier  who  receives  them,  while  the 
value  of  the  goods,  if  staple,  may  be  tested  by  the  bank 
through  market  quotations. 


The  Bank  Loan  31 

There  may,  however,  be  a  great  many  transactions  in 
which  the  bank  has  no  reliable  means  of  actually  testing 
the  value  of  the  goods,  and  in  such  cases  it  must  rely 
upon  what  it  knows  of  the  man  who  secures  the  discount 
from  it.  This,  however,  is  always  a  serious  problem  with 
the  bank.  Whatever  the  nominal  security  it  has  as  an 
immediate  protection  against  loss,  its  ultimate  security 
rests  upon  the  solvency  and  good  faith  of  the  borrower 
and  hence  the  necessity  of  carefully  testing  his  reliability, 
not  merely  from  a  moral  standpoint,  or  in  intention,  but 
from  a  strict  commercial  standpoint  as  well.  The  per- 
son who  discounts  such  bills,  of  course,  holds  a  contingent 
liability  until  the  amount  is  paid  by  the  drawee. 

Documented  bills  of  exchange  are  much  preferred 
among  bankers  to  ordinary  promissory  notes  because 
they  reveal  at  once  the  purpose  for  which  the  loan  is 
made,  while  a  note  does  not  show  in  what  sort  of  a  trans- 
action the  debt  originated.  Acquaintance  with  the 
principals  in  the  transaction  and  a  knowledge  of  the  busi- 
ness which  caused  the  obligation,  obviously,  are  valuable 
facts  for  a  banker  to  know  in  dealing  with  credit. 

Bankers'  Acceptances 

Another  type  of  bills  of  exchange  may  now  be 
described.  B,  who  buys  goods  from  A,  may  find  it  to 
his  advantage  to  induce  his  own  bank  to  accept  for  him. 
That  is  to  say,  instead  of  accepting  a  draft  on  himself, 
he  may  have  arranged  with  A,  the  seller,  that  a  bank 
shall  accept  the  draft  presented.  This  means  that  the 
bank  agrees  to  pay  the  claim  when  it  falls  due.  Of 
course,  the  hsink  will  then  collect  from  the  buyer  of  the 
goods  who  has  induced  it  thus  to  stand  in  his  place,  or, 
what  amounts  to  the  same  thing,  it  has  arranged  with  the 
buyer  that  he  shall  pay  in  the  amount  of  the  claim  to  it 


32  American  Banking 

on  the  date  when  it  is  due,  so  tiiat  the  transaction  merely 
amounts  to  the  buyer's  meeting  the  claim  at  his  bank  on 
the  specified  date.  This  is  a  banker's  acceptance.  The 
bank  in  this  case  has  substituted  its  security  for  that  of 
the  buyer  of  the  goods.  He  may  have  left  with  it  securi- 
ties sufficient  to  indemnify  it  in  case  of  his  failure  to  pay, 
or  may  otherwise  have  protected  the  institution. 

It  is  clear,  however,  that  A,  the  seller  of  the  goods, 
will  find  it  much  easier  to  dispose  of  this  banker's  accept- 
ance than  to  discount  or  sell  that  of  the  buyer 
individually.  Indeed,  the  banker 's  acceptance  may  be  so 
good  that  it  can  be  sold  without  any  indorsement  or 
undertalring.  It  is  equivalent  to  a  time  draft  on  the  bank 
which  has  accepted  it  so  that  A,  the  seller,  may  not  need 
to  go  through  the  process  of  discounting  with  his  bank, 
indorsing  or  guaranteeing  the  amount  of  the  loan,  or 
other^nse  binding  himself. 

This  is  commercial  paper  of  the  purest  type.  It  grows 
out  of  a  commercial  transaction  and  it  is  liquid  in  the 
highest  sense  because  it  is  the  obligation  of  a  bank.  On 
the  face  of  any  such  transaction  it  is  probable  that  the 
operation  is  a  commercial  one.  It  may,  of  course,  have 
been  undertaken  for  some  purely  financial  purpose,  but 
in  this  case,  as  in  others,  it  is  possible  to  make  sure  that 
the  transaction  is  commercial  by  specifying  or  identify- 
ing the  goods  on  which  the  acceptance  is  based.  The 
status  of  bankers'  acceptances  under  the  federal  reserve 
system  will  be  explained  shortly. 

TEST  QUESTIONS 

1.  In  what  three  forms  may  a  l)orrower  secure  a  personal 
loan  at  a  bank? 

2.  "What  two  ways  of  giving  security  on  bank  loans  are  most 
common  in  commercial  practice? 


I 


The  Bank  Loan  33 

3.  Explain  bank  discounts.    What  determines  the  rate? 

4.  Explain  the  use  of  drafts  in  commercial  transactions. 

5.  What  is  a  collateral  loan?    How  is  it  secured? 

G.  What  is  a  call  loan,  and  how  is  it  used  in  commercial 
affairs  ? 

7.  W^hat  are  ' '  documented  bills  of  exchange ' '  ?  Give  a  con- 
crete example  showing  how  to  use  them. 

8.  Explain  bankers'  acceptances.  How  are  they  used  in 
business  transactions?  What  advantages  do  they  possess  over 
some  other  types  of  loans? 


CHAPTER  IV 
special  problems  in  loans 

Testing  the  Boreower 

Banks  have  various  ways  of  testing  the  solvency  of 
their  borrowers  for  the  purpose  of  determining  their  title 
to  credit.  At  some  banks,  it  is  still  the  custom  to  have 
borrowers  make  up  a  statement  of  assets  and  liabilities 
Avlien  asking  for  a  large  loan,  or  if  they  are  regiilar  bor- 
rowers, constantly  in  need  of  accommodation,  and  as 
constantly  repaying  it,  so  that  they  have  a  regular  line  of 
trade  at  the  bank,  to  require  them  to  make  regular  state- 
ments of  condition  to  the  officers  of  the  institution.  These 
statements  may  be  made  semi-annually,  or  quarterly,  or 
even  monthly,  according  as  the  officers  of  the  bank  deem 
best,  and  as  the  activity  of  the  business  of  the  borrower 
seems  to  require.  Evidently  a  borrower  whose  business 
was  rather  sluggish,  would  not  have  to  be  called  upon 
to  make  such  statements  as  often  as  one  who  did  a  large 
business,  made  immense  profits,  or  incurred  heavy  losses, 
through  the  rapid  turnover  of  his  capital  in  business 
transactions.    Figure  1  shows  a  typical  statement. 

The  banker,  himself,  especially  in  small  towns,  has  a 
very  fair  idea  of  the  character  of  the  operations  in  the 
business  of  his  customers.  His  customers  are  likely  to 
make  a  confidant  of  him  to  some  extent  and  by  knowing 
the  amount  of  capital  they  control  and  the  volume  of 
their  receipts  as  deposited  with  him,  he  gets  a  good  work- 
ing knowledge  of  what  they  are  doing  without  being 

34 


f 

Date  of  Partnership 

Statement  OF 

f 

General  Partners 

Business 

^ Amount  Con- 

NaME                                            tributed.            s 

To            

- 

and  give  other  mate 

5 
ir 

A 

If  the  firm  has  any  branch  offices  state  location  and  how 

Cash  on  Hand  and 

Accounts  Receivable 

Merchandise 

If  the  firm  or  any  member  is  connected  with  any  other  b 

Other  Quick  Assets  ( 

•• 

/ 

I 


TATEMENTOF 

tusiNESs Address  . 


We  make  the  following 


ASSETS 


Cash  on  Hand  and  in  Banks. 

Accounts  Receivable 

Notes  Receivable 

Merchandise 

Other  Quick  Assets  (Itemize; 


Land  and  Buildings 

Machinery  and  Fijctures. 
Other  Assets  [Itemize)  . . 


Merchsadlse.    Co  what  basis  valued,  cost  or  market. . . 

Finished  $ Unfinished? Raw  $ 

If  any  goods  are  on  consignment,  state  amoun 


Sales  and  Profits  Last  Fiscal  Year.    Net  sales  8. , 

Net  profits  S 

Accounts  and  Notes  Receivable.      If  any  past  due 


branches  or  similar  n 


:  due  from  members  of   the  firm,   employees, 


Bonds  and  Stocks.    State  general  character  and  if  readily  salable  a 
'alue  stated , . . , 


Insurance.     Fire,  on  Buildings  $ Merchan- 
dise $ Life,  in  favor  of  firm  $ 


LIABILITIES 


Accounts  Payable 

Notes  Payable  to  Banks 

Notes  Payable  to  Others 

Deposits 

Other  Current  Liabilities  (Iter 


Current  Liabilities. 

Mortgages 

Other  Deferred  Liabilities  (Itemize) 


Current  and  Deferred  Liabilities. 

Net  Worth 


Contineent  Liability.    As  indorser  $. . 

As  guarantor  $ [ 

assigned  except  as  follows: 


have  been  sold  c 


Accounts  and  Notes  Payable.    If  any  are  past  due  state  amount 


fiscal     year 
)on. 


Mortgaeea  and  Other  Liens.    State  due  date  of  mortgages  and  o 


Is  mortgage  a  lien  on  any  c 

If  any  other  liens  on  assets,  state  amount  and  < 


Reserves  and  Depreciation.    State  what  provision  is  made. , 


We  hereby  certify  that  the  foregoing  figures  a 


this  sheet  a 

Signed  this day  of. 


t  showing  of  our  financial  condition. 

Firm  Name. 


if  our  finn  and  that  tbey  and  the 


lined  on  both  sides  of 


Fio.  1.— FeOer.al  Reserve  Bank  of  New  York  Statement  Fonn 


c 


Date  of  Expiration 

General  Partners 

Special  Partners 

Name 

'^r.'"°' 

^^:^Bu^^. 

Naub 

'^S^"- 

PartntT^ 





if  the  firm  has  any  branch  offices  state 

ocation  and  how  accounts  arc  handled 

U  the  6rm  or  any  member  is  connected  with  any  other  b 


e  of  the  business  and  extent  to  which 


What  is  the  practise  of  the  firm  in  regard  to  trade  discounts? . 


Are  books  audited  by  a  certified  public  accountant? Give  date  of  last  audit 


Location  and  Description  of  Land  Owned 


Mtgd.  for         Insured  for 


Title.     The  legal  and  equitable  (itle  to  all  pieces  of  above  described  real  estate  is  solely  in  the  r 
of  the  firm,  except  as  follows.. . 


:  of  the  meroben 


Special  Problems  in  Loans  35 

obliged  constantly  to  refer  to  their  statements.  Indeed, 
a  local  banker  of  intuition  often  has  an  instinctive  idea 
when  to  make  and  when  to  refuse  a  loan  that  is  far  better 
than  any  study  of  statements  of  assets  or  liabilities,  how- 
ever accurate  these  may  be.  When,  however,  the  place  in 
which  the  bank  is  situated  is  larger,  and  when  the  banker 
does  not  personally  know  the  borrowers  as  well  as  the 
local  banker  does,  when  neither  the  officers  of  the  bank 
nor  the  directors  are  closely  and  personally  familiar  with 
the  paper  of  their  localities,  when  they  are  not  able  to 
judge  accurately  of  the  personal  uprightness  and  hon- 
esty of  the  men  who  are  making  statements  to  them — 
when  all  or  several  of  these  conditions  are  noted,  it 
becomes  necessary  to  employ  a  more  complicated  method 
of  procedure. 

Studying  Credit 

The  study  of  credit  then  becomes  a  complex  matter  in 
which  all  possible  methods  must  be  employed,  and  in 
which  the  duty  of  passing  upon  credits  may  well  be 
intrusted  to  skilled  officers  who  spend  their  whole  time 
in  that  branch  of  banking.  As  a  result,  many  large  banks 
have  expert  accounting,  legal,  and  engineering  staffs  con- 
nected with  their  institution  whose  business  it  is  to 
furnish  reports  upon  applications  for  loans  and  credit. 

Such  officers  \vill  be  likely,  when  a  borrower  applies  for 
a  loan,  to  require  a  statement  of  assets  and  liabilities 
which  has  been  prepared  by  a  certified  public  accountant 
rather  than  by  the  bookkeeper  of  the  concern  itself.  He 
will  want  this,  not  because  he  necessarily  distrusts  the 
firm's  own  statement,  but  because  the  judgment  of  an 
outsider  is  likely  to  be  less  biased  and  more  in  harmony 
with  general  conditions  in  the  business  world.  Such 
statements  by  certified  public  accountants  should,  and 


36  American  Banking 

usually  do,  exhibit  not  merely  the  character  of  the  assets 
and  liabilities  but  also  the  degree  of  their  liquidity  and 
many  other  important  considerations. 

Besides  this,  the  credit  department  of  a  large  bank 
will  want  to  be  informed  concerning  a  number  of  points 
which  in  the  small  local  institutions  are  obtained  through 
the  immediate  observation  of  the  officers  and  directors  of 
the  bank.  The  firm's  standing  in  its  own  line  of  business, 
the  character  of  its  management,  the  promptness  with 
which  it  pays  its  debts,  and  a  variety  of  other  circum- 
stances will  all  fig-ure  in  this  connection.  The  banker 
himself  cannot  get  this  information  directly,  and  usually 
derives  it  from  credit  agencies  or  through  concerns  which 
make  a  business  of  ascertaining  all  the  facts  that  can  be 
learned  with  regard  to  different  concerns,  arranging 
these  in  their  proper  order,  making  them  serviceable  to 
students  of  credit,  and  supplying  them  in  condensed 
form,  for  a  consideration,  to  those  who  want  them.  Tak- 
ing such  statements  in  conjunction  with  the  information 
derived  from  the  borrower  himself,  supported  by  the 
examination  of  the  certified  accountant,  the  credit  bureau 
of  a  bank  is  able  to  pass  with  great  certainty  upon  the 
quality  of  the  paper  presented  to  it  for  discount. 

Buying  Paper 

Careful  study  of  credit  becomes  specially  important 
when,  as  is  often  the  case,  the  bank  finds  itself  vrith  idle 
funds  which  it  cannot  employ  in  its  own  locality.  It 
frequently  happens  that  a  bank  finds  its  vaults  full  of 
funds  while  it  is  unable  to  loan  further  in  the  community 
where  it  is  situated.  This  inability  to  loan  may  be  due 
to  a  superabundance  of  capital  or  to  lack  of  enterprise 
on  the  part  of  the  community,  or  to  lack  of  openings  for 
new  investments.    Whatever  the  cause  may  be,  this  is  an 


Special  Problems  in  Loans  '       37 

unsatisfactory  condition  for  the  bank  and  makes  it  neces- 
sary that  the  institution  should  find  an  outlet  for  its 
funds  elsewhere. 

Such  an  outlet  may  be  found  by  the  bank  through  a 
redeposit  of  its  funds  with  some  other  bank  which  is 
willing  to  allow  an  interest  thereon.  In  that  event  the 
funds  continue  to  be  available  on  call,  but  the  rate  of 
interest  earned  is  usually  low. 

Or  the  bank  with  surplus  funds  may  loan  them  in  a 
distant  market  on  collateral  security — an  operation 
which  usually  means  that  the  funds  are  employed  for 
stock  market  si^eculation. 

Conservative  banks,  which  have  large  surplus  funds 
that  can  be  counted  upon  for  some  months  in  advance 
and  which  are  able  to  gauge  the  borrowing  demand  of 
their  communities  with  some  accuracy,  prefer  to  use  such 
excess  funds  in  buying  paper  issued  by  firms  outside  of 
their  own  immediate  range  of  custom.  By  buying  such 
paper  they  secure  a  loan  of  greater  stability  and  perma- 
nence than  they  would  by  placing  their  funds  on  call 
secured  by  stocks  or  bonds,  while  the  loans  yield  them  a 
much  better  interest  than  they  could  usually  get  by  rede- 
positing  their  funds  mth  some  other  bank.  For  this 
reason  investment  in  good  sound  paper  is  much  favored 
by  bankers  of  the  conservative  type  and  the  question  is 
merely  that  of  testing  the  paper  and  of  getting  hold  of  it 
through  some  recognized  channel. 

The  bank  which  thus  places  its  funds  abroad  has  not 
always  the  facilities  for  testing  the  paper  nor  has  it  the 
regular  communication  w^ith  borrowers  who  want  funds 
from  outside  their  locality.  Such  borrowers,  however, 
exist  in  large  numbers.  They  may  prefer  to  place  their 
paper  very  widely  for  convenience'  sake,  or  because  they 
would  rather  have  it  scattered  through  a  great  number 


38  American  Banking 

of  banks,  or  because  they  can  thus  get  a  lower  rate  of 
interest,  or  for  any  one  of  a  variety  of  reasons.  It  is 
enough  to  say  at  this  point  that  there  is  a  supply  of  such 
paper  seeking  a  market  throughout  the  country,  and  that 
there  are  banks  with  surplus  funds  which  they  would 
like  to  invest. 

*' Rediscounts'' 

One  means  of  bringing  together  the  distant  bank  and 
the  distant  borrower  is  seen  in  the  "rediscount."  A 
city  bank  may  have  on  hand  a  quantity  of  good  paper 
in  which  its  funds  are  temporarily  *'tied  up."  It  does 
not  question  the  goodness  of  the  paper  but  it  may  see  an 
opportunity  for  investing  its  funds  at  a  much  higher 
rate  of  interest.  Or  it  may  find  that  some  one  of  its  old 
borrowers  needs  substantial  assistance  and  yet  it  may 
not  be  in  a  position  to  make  further  loans  to  him  in  the 
existing  state  of  its  liquid  resources.  Under  such  circum- 
stances the  bank  may  deem  it  advisable  to  get  rid  of  a 
part  of  the  paper  which  it  is  carrying  among  its  assets. 
Or  such  a  bank  may  be  well  aware  that  other  banks  at  a 
distance  will  come  to  it  for  loans  or  investments  for  their 
surplus  funds,  and  so  it  may  keep  itself  stocked  up  in 
advance  with  rather  more  paper  than  it  would  otherwise 
think  best  to  carry. 

Under  such  circumstances,  suppose  an  out-of-town 
banker  to  make  application  to  it  for  paper.  It  may  be 
very  glad  to  transfer  some  of  the  investments  'with  which 
it  is  over-supplied,  charging  the  new  buyer  a  small  per 
cent  for  the  accommodation  afforded  him  in  giving  him  a 
good  investment  for  his  funds.  The  out-of-town  banker 
will  be  glad  to  get  the  paper  for  the  reasons  already 
noted,  and  for  the  further  reason  that,  in  buying  such 
paper,  he  has  a  tacit  guarantee,  if  not  an  explicit  one,  of 


Special  Problems  in  Loans  39 

the  goodness  of  what  he  buys.  In  the  event  of  difficulty 
in  collection,  the  bank  from  which  he  purchased  will 
assist  in  getting  in  the  funds,  while  in  any  event  the  insti- 
tution which  originally  took  the  paper  has  subjected  it  to 
its  own  test.  So  the  local  banker  feels  an  added  sense 
of  security  in  making  the  purchase.  The  reverse  of  the 
transaction  occurs  when  the  bank  desiring  to  get  funds 
in  place  of  investments  offers  paper  to  another  bank 
with  its  own  indorsement  and  is  credited  with  the 
proceeds. 

Such  transactions  are  called  "rediscounts."  Transac- 
tions of  this  kind  are  made  continually  to  a  very 
considerable  extent  and  are  beneficial,  not  merely  for  the 
reasons  of  convenience  already  set  forth,  but  because 
they  aid  in  redistributing  the  capital  of  the  community 
to  those  points  where  it  is  wanted,  while  placing  the 
investments  of  the  country  at  those  points  where  invest- 
ments are  wanted. 

Rediscounting  under  the  Reserve  Act 

The  Federal  Reserve  Act  was  designed  to  facilitate  this 
process  of  rediscount.  It  provides  for  the  discount  of 
notes,  drafts,  and  bills  of  exchange  growing  out  of  com- 
mercial, industrial,  or  agricultural  transactions,  and  also 
bankers'  acceptances. 

Originally  bankers'  acceptances  were  limited  to  those 
based  on  the  exportation  or  importation  of  goods,  in 
order  to  avoid  an  undue  development  of  the  acceptance 
business  at  the  start.  Now,  however,  acceptances  based 
on  domestic  shipments  accompanied  by  title  documents  or 
warehouse  receipts  maturing  in  not  more  than  three 
months'  sight  may  also  be  discounted. 

The  Federal  Reserve  Act  also  provides  that  there  may 
be  bought  in  the  open  market,  subject  to  prescribed  regu- 


40  American  Banking 

lations,  bills  of  exchange  and  bankers'  acceptances.  In 
framing  the  bill  it  was  originally  intended  to  include 
notes,  so  that  the  open  market  transactions  would  have 
been  upon  the  same  basis  as  the  discount  transactions, 
the  difference  between  the  two  being  that  in  the  latter 
case  the  paper  would  have  been  protected  by  the  indorse- 
ment of  a  member  bank,  while  in  the  former  case,  such 
indorsement  would  not  have  been  required.  Before  the 
bill  finally  came  to  a  passage,  however,  it  was  determined 
to  omit  notes  on  the  ground  that  the  purchase  of  single- 
name  paper  of  this  kind  in  the  open  market  might  expose 
the  banks  to  some  hazard.  Since  they  would  not  be  in 
as  good  a  position  to  judge  the  paper  as  the  member 
banks  themselves,  they  might  from  time  to  time  take 
paper  which  was  not  thoroughly  satisfactory. 

What  has  been  said  makes  it  plain  that  only  a  part  of 
the  paper  held  by  the  rank  and  file  of  the  banks  is  eligible 
for  rediscount  with  federal  reserve  banks  and  that  only 
a  part  of  the  paper  currently  sold  in  the  open  market  is 
available  for  purchase  by  such  banks.  A  member  bank 
may  have  loaned  funds  to  a  merchant  in  order  to  enable 
him  to  extend  his  business.  It  may  be  well  aware  when 
the  loan  is  made  that  the  merchant  intends  to  enlarge 
his  building  or  to  construct  a  new  one,  or  it  may  have 
made  the  loan  for  the  purpose  of  enabling  an  individual 
to  purchase  stocks  and  bonds  and  hold  them  in  the  expec- 
tation of  the  advance  in  their  value;  or  it  may  have 
advanced  funds  for  the  purpose  of  enabling  the  borrower 
to  invest  in  real  estate  and  await  an  advance  in  the  value 
of  land.  Good  banking  practice  does  not  permit  the  mak- 
ing of  any  loans  of  this  sort  on  long  terms.  Stock  loans 
are  usually  made  on  call — that  is  to  say,  pajment  may  be 
demanded  whenever  the  bank  desires.  Other  loans  of  the 
kinds  referred  to  may  be  made  for  periods  of  four  or  six 


Special  Problems  in  Loans  41 

months,  with  the  understanding  that  they  will  be  renewed 
for  another  four  or  six  months.  In  some  parts  of  the 
country  there  is  a  good  deal  of  such  paper  in  banks. 

The  Federal  Reserve  Act  expressly  pennits  certain 
classes  of  national  banks  to  loan  25  per  cent  of  their  capi- 
tal and  surplus  upon  notes  running  not  to  exceed  five 
years  in  all,  secured  by  farm  lands.  The  purpose  of  this 
provision  is  to  enable  banks  to  lend  to  farmers  who  can 
offer  land  as  security,  but  who  are  practically  unable  to 
offer  any  other  security  and  who  need  funds  to  carry  on 
their  operations  for  a  long  period.  Such  loans,  however 
desirable  they  may  be,  and  however  sound  they  may  be, 
are  not  of  a  commercial  type.  They  are  non-liquid  in  the 
sense  that  they  run  for  relatively  long  periods. 

Moreover,  in  those  parts  of  the  country  where  such 
loans  are  common,  it  is  likely  to  be  true  that  the  maturi- 
ties of  the  loans  cannot  be  distributed — i.  e.,  that  many 
loans  will  fall  due  in  about  the  same  time.  The  effort  of 
the  bank  which  is  lending  on  short  term  in  ordinary  com- 
mercial business  is  to  distribute  the  maturities  as  much 
as  it  can,  so  that  there  will  be  a  steady  stream  of  matur- 
ing notes  throughout  each  month.  This  gives  the  bank  a 
regular  flow  of  funds  back  into  its  vaults,  and  it  can  use 
its  own  judgment  about  letting  them  out  again.  The 
other  classes  of  loans  are  of  an  entirely  different  type. 
There  is  no  way  of  distributing  them  well,  and  conse- 
quently no  way  of  collecting  steadily  and  readily.  Banks 
which  make  such  loans  must,  therefore,  count  upon  hav- 
ing to  carry  them  until  maturity.  They  will  not  find  it 
easy  to  rediscount  them,  at  least  until  they  approach 
maturity.  Neither  can  they  be  sure  of  inducing  the  bor- 
rower to  pay  at  maturity,  because  in  such  long  loans  his 
ability  to  liquidate  probably  depends  upon  the  success  of 
some  enterprise  in  which  he  has  been  engaged  in  the 


42  American  Banking 

meantime.  In  order  to  protect  itself,  the  bank  may  be 
practically  driven  to  renew  such  loans,  or  even  to  increase 
them. 

In  every  bank  which  does  a  commercial  banking  busi- 
ness, however,  there  w^ill  be  found  a  large  element  of 
paper  which  is  of  pure  commercial  type.  If  this  were  not 
true,  the  bank  would  not  be  a  bank  in  the  proper  sense 
of  the  term.  Every  bank,  therefore,  may  be  said  to  have 
two  distinct  classes  of  paper,  one  commercial  and  the 
other  non-commercial, — the  former  available  for  redis- 
count with  federal  reserve  banks,  the  latter  practically 
requiring  to  be  carried  until  maturity  and  constituting 
an  investment  of  longer  or  shorter  duration. 

Commercial  Purpose  of  Loans 

It  has  already  been  stated  that  in  those  cases  where  the 
borrower  goes  direct  to  his  bank  and  secures  accommoda- 
tion upon  his  own  note,  whether  protected  or  unprotected, 
there  is  nothing  in  the  transaction  itself  to  show  whether 
the  purpose  of  the  loan  was  commercial  or  not.  For  this 
reason,  it  has  sometimes  been  suggested  that  it  was  the 
intention  of  the  Federal  Reserve  Act  to  confine  the  dis- 
countable and  eligible  paper  to  that  which  bore  two 
names — those  of  the  buyer  and  seller,  as  already 
described.  Such  a  proposal  was  considered  at  one  time 
while  the  Act  was  in  process  of  preparation,  but  the  plan 
was  rejected,  as  is  shown  by  the  language  of  the  law 
which  describes  the  eligible  paper  as  that  whose  proceeds 
have  been  used  or  ''are  to  be  used"  for  the  purposes 
specified  in  the  Act.  This,  however,  necessitates  some 
investigation  on  the  part  of  the  bank  which  originally 
discounts  the  paper,  as  to  the  genuineness  of  the  commer- 
cial purpose  which  is  alleged  by  the  borrower  at  the  time 
he  gets  the  loan. 


Special  Problems  in  Loans  43 

How  can  the  bank  inform  itself  on  tliis  point! 

In  small  communities,  or  where  the  borrower  and  all 
his  operations  are  absolutely  known  to  the  bank,  it 
may  be  sufficient  for  the  borrower  simply  to  state  his 
purpose.  The  bank,  after  placing  the  funds  to  his  credit, 
can  tell  in  a  general  way  by  the  character  of  the  checks 
that  he  draws  what  the  funds  are  being  used  for. 

In  most  cases,  however,  particularly  where  loans  are 
large,  the  bank  gets  its  information  by  obtaining  from 
the  would-be  borrower  a  statement  of  his  condition,  of 
the  kind  already  described.  This  statement  shows  the 
value  of  his  business,  the  amount  of  short-term  assets  it 
holds,  the  quantity  of  goods  ready  for  market,  the  long- 
term  obligations  it  has  outstanding,  such  as  bonds,  and 
the  amount  of  bills  payable  or  short-term  obligations 
which  must  be  met  within  a  specified  period.  Such  a 
statement  form  is  shown  in  Figure  1. 

The  question  whether  the  business  is  liquid  or  not  is 
determined  by  making  a  comparison  of  its  short-term  or 
immediate  resources  with  its  short-term  or  immediate 
liabilities.  If  there  is  a  substantial  surplus  of  the  former 
over  the  latter  it  is  in  a  liquid  condition.  It  will  be  noted 
that  this  liquid  character  is  only  indirectly  related  to  the 
solvency  of  the  business.  A  business  might  conceivably 
be  in  a  very  liquid  condition  and  yet  insolvent,  in  the 
sense  that  its  total  assets  were  less  than  its  total  liabili- 
ties. On  the  other  hand,  the  business  may  be  highly 
solvent  but  very  far  from  liquid.  Its  funds  may  have 
been  allowed  to  become  ''tied  up"  in  long-term  opera- 
tions, so  that  it  is  in  want  of  immediate  funds  for  actual 
current  necessities. 

From  the  banker's  standpoint,  the  question  whether  a 
loan  to  a  commercial  firm  on  the  single-name  paper  of 
that  firm  is  desired  for  a  commercial  purpose,  depends 


44  American  Banking 

largely  upon  the  degree  in  which  the  assets  of  the  con- 
cern are  liquid.  If  they  are  not  very  liquid  it  is  fair  to 
assume  that  the  loan  is  practically  equivalent  to  supply- 
ing the  concern  with  more  capital,  which  is  to  be  steadily 
required  in  the  business  until  it  can  put  itself  upon  a  more 
liquid  basis. 

The  point  at  issue  here  can  be  understood  by  consid- 
ering one  or  two  illustrations.  A  borrower,  for  example, 
may  give  absolute  evidence  to  the  bank  that  a  sum  of  a 
thousand  dollars  which  he  is  borrowing  is  to  be  used  in 
a  strictly  commercial  transaction  and  yet  this  knowledge 
may  show  nothing  w^hatever  of  the  borrower's  general 
policy,  because  it  may  be  necessary  for  him  to  use  a 
similar  amount  of  his  own  current  receipts  for  purposes 
which  are  practically  equivalent  to  the  investment  of 
more  funds  in  his  business.  The  real  test  is  whether  the 
aggregate  of  the  loans  and  receipts  of  the  concern  are 
intended  to  be  used  for,  and  are  in  fact  used  to  antici- 
pate, income  from  the  claims  that  will  mature  within  a 
short  time.  If  such  is  the  case,  the  concern  is  in  a  liquid 
condition  and  its  paper  may  fairly  be  discounted  as  com- 
mercial paper.  Of  course  this  test  is  a  somewhat  general 
and  uncertain  one,  and  in  applying  it  the  judgment  of 
the  bank  which  makes  the  loan  must  be  the  principal 
guide. 

Single-Name  v.  Double-Name  Paper 

Relatively  little  such  single-name  paper  exists  in  for- 
eign countries.  The  course  of  banking  in  the  United 
States  has,  however,  been  such  as  to  develop  single-name 
paper  to  an  unprecedented  extent,  the  makers  dividing 
their  obligations  among  a  great  number  of  banks  of  rela- 
tively small  capitalization.  This  is  the  case  with  some  of 
the  great  borrowers  of  the  country.    Their  paper  is  made 


Special  Problems  in  Loans  45 

in  notes  of  standard  size — as  five  hundred  dollars,  one 
thousand,  five  thousand — and  this  is  then  sold  to  any 
banker  who  has  spare  funds.  In  many  cases,  it  is  prac- 
tically an  advance  of  capital  for  further  extension  of 
the  business.  In  foreign  countries  the  paper  held  by 
banks  is  principally  two-name,  and  the  banker  buys 
or  discounts  it  with  reasonable  assurance  that  it  will  be 
self-liquidating,  i.  e.,  that  the  sale  of  goods  or  the  con- 
summation of  the  transactions  for  wliich  the  money  has 
been  borrowed  will  result  in  providing  the  means  to  set- 
tle the  account  when  the  time  comes. 

Many  persons  who  have  not  examined  the  subject 
closely  are  inclined  to  inquire  why  the  Federal  Reserve 
Act  should  have  limited  the  operations  of  federal  reserve 
banks  so  closely  to  commercial  paper.  In  some  parts  of 
the  country  farmers,  for  example,  who  desire  long-term 
loans  in  order  to  enable  them  to  buy  or  pay  for  land, 
suggest  that  a  banking  system  wliich  is  limited  to  the 
field  covered  by  the  Federal  Reserve  Act,  is  not  very 
useful.  Elsewhere,  the  suggestion  is  from  time  to  time 
made  that  the  restrictions  are  so  great  as  to  prevent  the 
system  from  serving  a  general  popular  purpose.  Crit- 
icisms like  these  ignore  the  real  purpose  for  which  a 
commercial  banking  system  exists,  and  particularly  the 
purposes  for  which  a  reserve  system  exists.  They  over- 
look the  fact  that  a  main  function  of  banking  is  to  enable 
persons  who  have  debts  to  pay  to  get  the  funds  with 
which  to  meet  tliem,  and  that  banking  is  a  process  of 
equalizing  the  supply  of  fluid  funds  among  those  who 
require  them. 

The  federal  reserve  system  is  intended  to  provide  just 
this  means  of  liquefying  and  equalizing  resources.  It  is 
not  a  method  of  supplying  capital  to  borrowers  for 
investment.    Such  investments  as  it  makes  are  made  for 


46  American  Banking 

the  purpose  of  affecting  the  rate  of  interest  in  the  market, 
and  of  enabling  banks  to  meet  their  own  maturing  obliga- 
tions without  difficulty.  While  this  service  appears  to  be 
directly  and  primarily  for  the  benefit  of  the  commercial 
world,  it  is  beneficial  indirectly  to  every  member  of  the 
community.  A  bank's  suspension  affects  the  whole  com- 
munity, and  the  same  is  true  of  the  failure  of  any  com- 
mercial enterprise.  Important  as  is  the  function  of 
supplying  capital  to  those  who  need  it  for  long-term 
investment,  this  is  the  field  of  finance  and  not  of  banking. 
Preventing  suspension  of  payment  and  insuring  constant 
covertibility  of  demand  obligations  into  cash  is  quite  as 
great  a  service  to  the  public  at  large  as  it  is  to  those 
bankers,  merchants,  and  traders  generally  for  whom  the 
service  is  immediately  performed. 

The  Note  Beoker 

Single-name  paper  will  no  doubt  maintain  itself  in  the 
United  States,  and  it  is  worth  while  to  observe  how  such 
paper  is  distributed.  Within  recent  years,  ''note  bro- 
kers ' '  have  assumed  in  part  the  function  of  taking  large 
quantities  of  such  single-name  commercial  paper  off  the 
hands  of  the  makers  and  placing  the  paper  with  banks 
which,  for  any  of  the  reasons  sketched,  want  addi- 
tional investments  of  this  kind.  In  such  cases,  a  firm 
desirous  of  borrowing  say  $100,000  may  make  up  twenty 
notes  of  $5,000  each  or  may  put  the  obligation  into  any 
other  of  the  forms  of  commercial  paper  practicable. 

The  note  broker,  who  has  capital  of  his  own  to  use  as  a 
basis  for  his  business,  will  then  purchase  this  $100,000 
of  paper  at  a  specified  rate  of  interest — say  6  per  cent. 
He  vnll  then  go  from  bank  to  bank,  usually  developing 
a  regular  set  of  customers  just  as  a  traveling  sales-agent 
might.    He  will  dispose  of  the  paper  to  the  various  banks 


Special  Problems  in  Loans  47 

which  have  funds  that  they  desire  to  invest,  charging 
each  bank  a  small  commission.  This  commission  repre- 
sents payment  for  the  work  he  has  performed  in  testing 
the  paper  and  acting  as  an  intermediary  between  the 
original  borrower  and  the  bank  which  ultimately  takes 
the  paper  as  an  investment.  His  commission  also 
includes  a  rate  of  interest  upon  such  capital  of  his  own 
as  he  may  keep  employed  in  transacting  the  business. 
The  bank  is  saved  expense  and  trouble  in  investigating 
the  character  of  the  paper  it  gets,  and  is  ready  to  pay 
the  commission  in  lieu  thereof. 

Doubt  has  been  raised  by  some  as  to  the  safety  of 
investments  thus  made  by  banks,  but  experience  has 
shown  that,  when  carried  on  under  proper  conditions,  the 
method  thus  sketched  is  an  unimpeachable  mode  of  redis- 
tributing bank  loans  and  bank  paper.  James  H.  Eckels, 
for  several  years  President  of  the  Commercial  National 
Bank  of  Chicago,  has  asserted  that  out  of  an  enormous 
total  thus  bought  by  his  institution  only  $10,000  failed 
to  be  paid  promptly  and  of  this  a  substantial  percentage 
was  afterwards  recovered.  This  may  be  an  exceptionally 
favorable  showing,  but  in  the  main  the  distribution  of 
paper  as  to  the  methods  indicated  is  a  growing,  and  on 
the  whole  satisfactory,  plan. 

Actual  Bank  Loans 

It  is  a  matter  of  some  interest  to  note  how  banks  have 
actually  apportioned  their  funds  among  various  classes 
of  paper  and  how  the  actual  apportionment  varies  accord- 
ing to  the  location  of  the  different  banks.  The  comp- 
trollers of  the  currency  now  annually  publish  figures  fur- 
nished by  the  banks  which  show  the  character  of  the 
paper  held  by  national  banks  classified  as  demand  paper 
with  one  or  more  indi^ddual  or  firm  names,  demand  paper 


48  American  Banking 

collateraled  by  stocks,  bonds,  and  other  securities,  time 
paper  with  two  or  more  indi\adual  or  firm  names,  time 
paper  with  single  name,  and  time  paper  secured  by  stocks, 
bonds,  etc.  The  amount  and  percentage  of  each  class  of 
loans  made  by  the  banks  on  or  about  June  14,  1912,  1913, 
and  1914,  respectively,  were  as  follows: 

June  14,  1912  Juiie  4,  1913  June  30,  1914 

Per  Per  Per 

Class  Amount  cent  Amount  cent  Amount  cent 

On    (kmajirl,    paper    with    one    or 

more   Individual   or   Ann   names      $571,345,681         9.0        $003,735,269        9.8        $616,911,197         9.6 
On    demand,     secured    by    stocks, 

bonds,    ajid    other    personal    se- 

curlUes      985.421,576       16.6  980,989,427       16.0       1,030,976,740       16.1 

On  time,   paper  with  two  or  more 

individual   or   firm    names 1,973,453,245      33.1       2,032,569,547       33.1      2,060,059,475       32.1 

On  time,   single-name  paper  with- 
out   other    security 1.198,505,089      20.1       1,201,484,534       20.5       1.336,093,305      20.8 

On  lime,  secured  by  Btoclts,  bonds, 

and     other    personal    securities, 

or   on   mortgages   or   otlier   real 

estate     security      1,225,178,240       20.0       1,204.249,356      20.6       1,372,828,438       21.4 

Total   $5,953,904,431     100.0     $0,143,028,133     100.0     $0,430,009,215     100.0 

The  figures  show  that  there  is  decided  difference  be- 
tween the  amounts  of  the  various  classes  of  paper  held 
by  banks  in  different  parts  of  the  country  and  that  the 
amount  of  the  various  classes  varies  considerably  from 
year  to  year  according  to  the  development  of  business. 
The  following  table  shows  the  amount  and  character  of 
the  loans  made  by  national  banks  in  the  city  of  New  York : 

Sept.  1.  June  7,  June  14,  June  4,  June  30, 

1910,  1911.  1912,  1913,  1914, 

Loans  and  discounts  39  baulss         4D  banks       37  banlis         3G  banjis  33  banks 

On    demand,     paper    with    one    or 

more    individual    or    firm    names     $9,948,094       $9,356,484     $17,796,847     $13,480,717        $12,952,708 
On     demand,     secured     by     stocks, 

bonds,     and     other    personal     se- 
curities*       328,145,005     331,736,088     320,897,301     302,904,033        372,091,290 

On    time,    pafier  with    two   or   more 

Individual  or   fli-m   names 170,008.890     177.331,562     171,791,524     178,030,288        192.530,756 

On    lime,    single-name    paper     (one 

person    or    tlrm).     without    other 

securities      170,708,005     197,030,419     219,172.889     189,754,147        228.852,438 

On  time,   secured   by   stocks,   bonds, 

and    other   personal   securities,    or 

on      real      estate      mortgages     or 

other    lieos    on    realty* 188.470.800     188,111,280     223,410,194     202,791,617        254,668,605 

Total      $873,880,800  $903,500,433  $959,068,755  $886,906,804  $1,061,095,803 

*  Including  notes  secured  by  deposit  of  commercial  paper,  chattel  mortgages,  real  estate  paper,  etc. 

Specializing  in  Loans 

From  the  tables  just  given  it  may  be  inferred  that 
banks  often  specialize  in  certain  classes  of  paper.    This 


special  Problems  in  Loans  49 

is  partly  due  to  the  different  character  of  the  paper  pre- 
senting itself  in  different  communities,  and  partly  to  the 
fact  that  banks,  like  other  institutions,  become  accus- 
tomed to  certain  kinds  of  transactions,  grow  expert  in 
carrying  on  those  transactions,  and  then  find  it  more 
economical  and  profitable  to  confine  their  business  to 
those  lines  in  which  they  are  most  experienced  and  for 
which  they  have  the  best  facihties.  This  leads  to  special- 
ization, which  is  now  carried  to  a  very  high  degree  in 
some  cities. 

Certain  banks  will  be  found  which  rarely  make  large 
loans  on  call  but  confine  themselves  to  time  paper  orig- 
inating with  commercial  houses.  Others  find  that  they 
have  a  clientele  consisting  largely  of  stock  operators, 
and  they  make  the  bulk  of  their  loans  upon  collateral 
security,  usually  upon  call.  Other  classes  of  business 
drift  away  from  them,  in  a  measui^e  at  least.  A  degree 
of  specialization  as  to  the  size  of  loans  also  exists,  some 
banks  practically  confining  themselves  to  loans  that  are 
not  below  a  certain  figure.  Other  banks  operate  very 
largely  in  loans  to  merchants  engaged  in  a  given  kind 
of  trade  and  become  familiar  with  the  pecuUar  needs  of 
that  trade,  the  periods  at  which  most  capital  is  likely  to 
be  wanted  by  borrowers,  and  the  conditions  upon  which 
accommodations  and  discounts  may  safely  be  granted. 

In  towns  where  the  chief  business  is  manufacturing 
in  certain  lines,  speciaUzation  may  be  carried  to  a  very 
high  degree,  wliile  at  the  same  time  the  banks  may,  for 
the  convenience  of  the  community,  conduct  a  general 
business  in  discomiting  local  mercantile  paper,  making 
loans  on  securities  to  individuals,  and  the  like. 

The  National  Bank  Act  has  to  some  extent  limited 
this  kind  of  specialization  by  restricting  the  amount  of 
the  loans  (in  relation  to  capital)  that  may  be  made  to 


50  American  Banking 

particular  individuals   or  firms — a  point  that  will   be 
dealt  with  elsewhere. 


TEST  QUESTIONS 

1.  By  what  means  does  a  bank  determine  the  financial  re- 
sponsibility of  its  borrowers? 

2.  How  do  banks  dispose  of  surplus  funds? 

3.  Explain  what  is  meant  by  rediscounting. 

4.  What  sort  of  commercial  paper  is  eligible  for  rediscount 
under  the  federal  reserve  system? 

5.  "What  is  the  limitation  placed  on  the  rediscount  of  bank- 
,ers'  acceptances? 

6.  How  does  the  rediscount  plan  of  the  federal  reserve  sys- 
tem enable  banks  to  meet  seasonal  requirements  for  money  in 
their  respective  communities? 

7.  Distinguish  between  single-name  paper  and  double-name 
paper.  How  is  this  question  related  to  the  federal  reserve 
system  ? 

8.  What  are  the  functions  of  a  note  broker?  Just  how  does 
he  carry  on  his  operations? 

9.  For  what  reasons  do  certain  banks  specialize  in  particu- 
lar kinds  of  loans?    Cite  a  concrete  case. 

10.     How  do  the  loan  conditions  vary  in  different  sections  of 
the  United  States? 


CHAPTER  V 

BANK   PEFOSITS 

How  Deposits  Are  Made 

The  ordinary  conception  of  ''making  a  deposit"  is 
that  of  taking  to  a  bank  actual  ' '  money  "  or  "  currency ' ' 
and  handing  it  in  over  the  counter  to  the  representative 
of  the  bank,  who  counts  it  and  credits  it  in  a  "pass  book." 
This  seems  to  be  the  clear  meaning  of  the  term  "deposit" 
—something  deposited  or  left.  As  a  matter  of  fact,  it 
must  be  regarded  as  a  totally  erroneous  conception  of 
the  bank  "deposit"  when  viewed  from  the  general  stand- 
point of  credit. 

It  is  true  that  a  bank  deposit  may  be  made  in  exactly 
the  way  indicated.  A  man  may  have  in  his  possession 
gold  coin,  and,  not  liking  the  weight  of  the  money,  may 
take  it  to  a  bank,  hand  it  in,  receive  credit,  and  then 
pay  his  debts  by  means  of  checks  upon  the  bank.  But 
it  is  equally  clear  that  other  things  may  be  ' '  deposited. ' ' 
Paper  currency  may  be  deposited,  and  this  may  be 
either  notes  issued  by  the  government  (which  are  prac- 
tically certificates  to  coin  in  the  vaults  of  the  Treasury), 
or  "notes"  issued  by  the  banks  themselves.  It  is  also 
possible  to  "deposit"  with  a  bank  "checks"  upon  other 
banks  which  are  simply  claims  to  "deposits"  in  those 
other  institutions.  All  these  methods  of  depositing  are 
constantly  in  vogue. 

But  it  is  possible  to  make  a  deposit  without  resorting 
to  any  of  them.    Suppose  a  would-be  borrower,  A,  who 

51 


52  American  Banking 

has  property  or  is  known  to  be  in  a  tliorouglily  solvent 
condition,  goes  to  a  bank  and  negotiates  a  loan.  That 
loan  may  be  allowed  him,  not  in  the  form  of  actual  coin 
or  currency,  but  simply  in  the  form  of  an  entry  in  a 
pass  book.  In  return  for  this  entry,  the  borrower  leaves 
with  the  bank  his  owti  note  secured  or  unsecured  by  col- 
lateral. In  this  case,  a  '' deposit"  has  been  created  just 
as  actually  and  just  as  truly  as  if  A  had  w^alked  into  the 
bank  with  a  sack  of  gold  coin  and  had  passed  it  over  the 
counter,  receiving  credit  for  it  in  a  pass  book  just  as  he 
did  when  he  left  his  o\\ti  note  for  a  similar  amount. 

Deposits,  then,  may  be  made  in  any  one  of  these  sev- 
eral ways.  Banks,  in  reporting  the  amount  of  their 
deposits,  do  not  distinguish  at  all  between  the  different 
ways  in  which  sucli  deposits  may  have  been  made,  but 
report  the  figure  as  a  lump  sum.  Merely  to  know,  there- 
fore, that  a  bank  has  ''$100,000  of  deposits"  throws  no 
hght  at  all  upon  the  way  in  which  these  deposits  were 
created,  though  it  may  safely  be  assumed  that  the  bulk 
of  them  are  credit  deposits. 

Classes  of  Deposits 

There  are  no  figures  from  which  it  can  be  positively 
stated  in  which  of  these  ways  the  greatest  quantity  of 
deposits  are  made  or  what  are  the  relative  amounts  of 
the  various  classes  of  deposits.  Observation  of  banking, 
however,  shows  conclusively  that  the  deposits  made  by 
actually  handing  in  coin  or  currency  over  the  counter 
is  comparatively  small.  A  very  large  volume  is  created 
by  handing  in  to  the  banks  claims  upon  other  banks  in 
the  form  of  checks  or  drafts.  Another  large  amount  is 
made  by  securing  credit  at  banks  and  leaving  a  personal 
or  firm  note,  secured  or  unsecured,  with  the  institution. 

It  should  be  noted,  however,  that  these  tsvo  methods 


Bank  Deposits  53 

are  substantially  identical.  There  is  no  difference  in 
principle  whether  A  is  credited  with  $1,000  at  the  First 
National  Bank,  as  a  result  of  his  having  left  there  his 
personal  note  for  $1,000,  or  whether  he^is  credited  at 
the  First  National  because  he  has  handed  in  a  check  for 
$1,000  drawn  upon  the  Second  National  by  B  who  got 
his  credit  with  the  Second  National  by  leaving  there  his 
own  personal  note.  In  the  second  case  (where  A  leaves 
a  check  drawn  by  B  to  his  credit),  the  First  National 
simply  takes  the  check,  collects  it  at  the  Second  National, 
and  places  the  amount  to  A's  credit.  There  is  a  dif- 
ference in  detail  because  in  this  form  of  the  transaction 
two  banks  and  two  individuals  are  involved.  The  legal 
relationships  created  are  slightly  different.  But  so  far 
as  the  banking  community  as  a  whole  in  relation  to  the 
commercial  community  as  a  whole  is  concerned,  there  is 
no  difference  whatever. 

This  fact  can  be  apprehended  even  more  clearly  by 
supposing  that  A  and  B  both  deal  at  the  same  bank — 
the  First  National.  B  may  then  get  his  credit  at  the 
First  National  by  leaving  a  personal  note,  secured  or 
unsecured,  and  may  then  draw  a  check  in  favor  of  A. 
A  deposits  the  check  at  the  First  National,  which  merely 
makes  a  transfer  of  the  credit  from  B  to  A.  In  every 
respect  then,  so  far  as  banking  principles  are  concerned, 
there  is  no  difference  between  these  two  types  of  trans- 
action. The  only  real  difference  in  the  making  of  deposits 
is  between  the  transaction  where  actual  coin  or  cur- 
rency is  left  with  the  bank,  and  that  where  the  deposit 
is  secured  by  creating  a  credit.  Such. credit  deposits 
unquestionably  exceed  those  made  by  leaving  coin  or 
currency  in  a  very  large  proportion. 

This  can  be  better  understood  when  it  is  stated  that  the 
total  individual  ''deposits"  reported  by  the  banks  of  the 


54  American  Banking 

United  States  in  the  last  annual  statement  to  the  Comp- 
troller (1914)  were  $18,517,700,000,  while  the  total  gold 
and  silver  money  in  circulation  in  the  United  States  on 
about  the  same  date  was  only  $3,738,300,000,  or  less  than 
one-fifth  of  the  deposits. 

Natuee  of  the  Deposit 

When  the  bank  grants  a  deposit  by  crediting  a  bor- 
rower on  its  books,  or  when  it  receives  a  deposit  in 
coin  or  currency,  it  binds  itself  to  pay  cash  on  demand. 
That  is  to  say,  any  holder  of  a  deposit  credit  in  a  bank, 
or  any  holder  of  a  check  given  to  him  by  the  owner  of 
such  a  deposit  credit,  is  in  position  to  go  to  the  bank  and 
demand  actual  money  or  currency.  The  bank  must  pay 
such  demands  when  presented,  or  close  its  doors.  In 
other  words,  the  deposit  credit  in  the  solvent  bank  can 
be,  and  is,  used  as  a  means  of  purchasing  power  which 
has  exactly  the  same  effect  in  making  a  demand  for 
commodities  as  an  equal  sum  in  money  or  currency. 

So  long  as  the  recipient  of  the  check,  or  the  holder  of 
the  deposit  credit,  believes  that  the  bank  is  in  a  position 
to  liquidate  any  such  obligation  when  presented  to  it,  the 
claim  on  the  bank  is  to  him  the  same  as  money  or  cur- 
rency. This  means  that  deposits  will  not  be  called  for  in 
cash  or  currency  to  anything  like  their  total  amount. 
It  is  entirely  conceivable  that  all  the  business  of  a  given 
community  should  be  done  with  a  single  bank,  and  that 
practically  all  the  business  of  the  town  should  be  trans- 
acted by  using  checks  instead  of  by  the  actual  passage 
of  currency.  If  such  were  the  case,  there  would  be  no 
reason  why  the  bank  should  not  go  on  granting  credit 
deposits  up  to  any  amount  that  it  considered  the  property 
of  the  community  would  warrant,  relying  upon  the  pay- 
ments from  individual  to  individual  to  offset  one  another, 


Bank  Deposits  55 

since  (by  the  terms  of  our  supposition)  coin  or  currency 
would  not  be  called  for  at  the  bank.  In  such  a  situation, 
there  would  be  no  reason  why  the  bank  should  keep  any 
coin  or  currency  on  hand. 

Relation  to  Currency 

The  fact  is  that  the  business  world  does  use  a  consider- 
able amount  of  coin  or  currency  in  actual  transactions. 
There  are  several  reasons  for  this.  Banks  are  not  uni- 
versally accessible ;  they  are  not  trusted  by  everyone ;  not 
everyone  has  a  bank  deposit  account ;  banks  do  not  care 
to  transfer  on  their  books  very  small  transactions ;  doubt 
is  felt  concerning  the  solvency  of  various  banks ;  and 
other  reasons  exist  which  make  it  imperative  for  banks 
to  be  in  a  position  to  supply  the  actual  demands  of  the 
community  for  coin  or  currency.  The  result  of  condi- 
tions in  the  business  w^orld  is  that  there  is  a  steady  flow 
of  coin  and  currency  into  and  out  of  the  bank,  certain 
sums  being  drawn  out  today  and  equally  large  sums 
being  left  there  by  other  persons  who  have  received  them 
in  the  course  of  their  business.  The  ebb  and  flow  of 
coin  and  currency  out  of  and  into  the  bank  is  like  water 
flowing  out  of  a  reservoir  which  is  fed  by  a  number  of 
pipes  supplying  substantially  the  same  amount  that  is 
drawn  off. 

How  large  should  this  reservoir  be?  In  other  words, 
how  much  must  a  bank  keep  on  hand  in  coin  or  currency 
in  order  to  make  its  deposits  good  and  to  compel  con- 
fidence throughout  the  community  that  a  check  presented 
at  the  bank  will  be  instantly  cashed? 

This  is  a  matter  that  can  be  determined  in  any  com- 
munity only  by  experience,  which  in  turn  depends  upon 
the  habits  of  the  community  itself.  The  amount  needed 
varies  from  country  to  country,  from  region  to  region, 


56  American  Banking 

and  from  town  to  town.  There  are  certain  rules  derived 
from  experience  which  are  of  use  in  the  matter,  and 
most  countries  have  laws  which  attempt  to  regulate  the 
practice  of  banks  in  this  regard,  but  the  actual  determina- 
tion of  the  amount  must  be  made  by  the  banker  himself. 
It  is  fundamental  to  his  interest  that  he  judge  it  cor- 
rectly, otherwise  confidence  in  his  institution  will  be 
lost. 

Distribution  of  Deposits 

In  practice,  the  business  of  the  community  is  performed 
by  a  great  number  of  banks,  and  it  is  the  relations 
between  these  banks,  and  between  them  and  the  com- 
munity, that  determine  the  distribution  of  coin  and 
currency,  and  ultimately  the  distribution  of  the  deposits. 
For  example,  if  ten  banks  exist  in  a  given  community, 
all  with  equal  capital,  it  is  clear  that  in  the  course  of 
business  each  one  will  be  likely  to  receive  some  claims 
upon  the  others.  Since  the  amount  of  credit  deposits 
that  each  can  grant  the  community  depends  largely  upon 
the  amount  of  casli  it  has  in  its  own  vaults,  it  will 
endeavor  to  collect  these  claims  from  the  banks  upon 
which  they  were  drawn,  at  the  earliest  possible  moment. 
It  is  clear  that  Bank  A,  wliich  has  claims  of  $1,000  each 
upon  banks  B,  C,  and  D,  can  be  prevented  from  collecting 
these  claims  in  cash  and  thereby  reducing  the  cash  on 
hand  in  those  other  banks,  only  if  banks  B,  C,  and  D 
have  each  a  claim  of  $1,000  upon  A.  In  such  a  case, 
the  obligations  will  be  offset  against  one  another  and 
no  coin  or  currency  will  be  shifted  from  one  to  the  other. 

In  practice,  no  such  exact  offsetting  or  compensation 
takes  place.  Bank  A  may  have  claims  aggTegating  $985 
against  B,  C,  and  D,  while  B,  C,  and  D  may  have  claims 
amounting  to  $900  against  A.    In  that  case,  A  will  be  the 


Bank  Deposits  57 

^et  gainer  by  the  day 's  transactions  with  the  other  banks 
of  $85  in  cash,  while  the  other  banks  will  lose  that  amount 
to  it.  If  B,  C,  and  D  kept  on  losing  in  this  way,  the  time 
would  come  when  they  would  no  longer  have  funds  with 
which-  to  meet  claims  presented  against  them.  They 
would  foresee  such  a  result  because  of  the  steady  reduc- 
tion in  their  cash  on  hand  and  would  endeavor  to  provide 
against  it  by  selling  out  their  assets.  If  they  were  suc- 
cessful in  doing  this,  and  if  the  drain  of  cash  continued, 
the  time  would  arrive  when  all  their  assets  would  be 
converted  into  cash  and  all  this  cash  transferred  to  some 
other  bank  or  banks.  Then  the  process  would  stop 
and  B,  C,  and  D  would  go  out  of  business.  A  condition 
of  this  kind  rarely  exists  in  actual  practice.  B,  C,  and  D 
may  lose  money  to  A  on  the  1st  of  the  month  and  may 
gain  it  back  on  the  2nd.  Or  they  may  steadily  gain  for 
the  first  half,  and  as  steadily  lose  for  the  second  half, 
of  the  month.  The  shifting  about  of  the  reserve  money 
between  the  banks,  however,  determines  the  relative 
amount  of  loans  that  each  is  able  to  make,  and  conse- 
quently determines  the  distribution  of  the  business  of 
the  community  among  the  banks.  Those  banks  which 
enjoy  the  greatest  confidence  on  the  part  of  the  com- 
munity are  the  ones  which  receive  the  greatest  amount 
of  checks  and  claims  on  other  banl^s,  and  which  are  con- 
sequently able  to  draw  on  the  others  to  the  greatest 
extent,  thus  taking  to  themselves  a  corresponding  pro- 
portion of  the  liquid  funds  of  the  community  and  using 
them  as  a  basis  for  further  bank  loans  to  ''depositors." 

Cancellation  of  Deposits 

From  what  has  been  said  it  is  clear  that  just  as  a 
deposit  is  made  without  the  use  of  money  it  may  also 


58  American  Banking 

be  destroyed  or  terminated  without  the  use  of  money. 
A  borrows  $1,000  from  the  bank,  giving  his  note  for  the 
amount  and  being  credited  therewith  on  the  books.  He 
pays  this  sum  to  B  who  may  himself  be  in  debt  to  two 
other  banks  in  sums  of  $500  each,  the  indebtedness  fall- 
ing due  on  the  day  when  he  gets  A's  check.  B  may  use 
A's  check  in  liquidating  these  payments.  In  such  a  case, 
$1,000  worth  of  bank  claims  against  the  community  has 
been  cancelled  by  the  creation  of  a  new  claim  amounting 
to  $1,000.  There  is  a  rearrangement  of  the  indebtedness 
among  the  banks  themselves,  but  that  is  all. 

It  is  thus  seen  that  the  credit  transaction  out  of  which 
the  deposit  usually  grows  may  be  brought  to  an  end 
and  cancelled  in  precisely  the  same  way  as  that  in  which 
it  was  created.  The  effect  of  the  credit  deposit  during 
its  life  has  been  merely  that  of  facilitating  exchanges  by 
rendering  goods  acceptable  in  payments  at  specified 
ratios  to  one  another,  the  judgment  of  the  banker  inter- 
vening and  operating  as  an  assurance  to  the  community 
that  the  borrower  has  goods  equal  to  the  amount  of 
funds  he  seems  to  have  within  his  control. 

It  is  e\'ident,  therefore,  that  a  general  rise  in  the 
amount  of  deposits  at  the  banks  indicates  merely  that 
the  banks  are  making  large  loans  all  around  to  the  com- 
munity. A  rise  in  the  amount  of  deposits  at  a  single 
bank  may  mean  nothing  more  than  a  transfer  of  the 
business  of  the  community  to  that  bank.  A  general 
decrease  in  the  amount  of  deposits,  taking  the  banks  as 
a  whole,  means  a  shortening  of  accommodations  extended 
to  the  community,  while  a  decline  in  the  deposits  of  a 
single  institution  may  mean  nothing  more  than  a  loss  of 
popularity  on  the  part  of  that  institution  and  a  transfer 
of  its  business  to  others. 


Bank  Deposits  59 

Significance  of  Deposits 

When  the  bank  deposits  of  a  country  are  seen  to  be 
steadily  growing,  this  may  be  taken  as  evidence  of  busi- 
ness activity  and  consequent  or  co-ordinate  activity  in 
the  extension  of  credit  for  the  purpose  of  supporting  the 
business  of  the  community.  Ordinarily,  therefore,  large 
deposits  are  equivalent  to  large  loans  and  large  loans 
are  obtained  when  borrowers  can  use  them  profitably  and 
when  they  are  able  to  impress  bankers  with  the  opinion 
tliat  the  enterprises  in  which  they  wish  to  engage  are 
sound  and  are  likely  to  be  profitable,  or  at  all  events 
that  they  have  behind  them  an  abundance  of  actual  wealth 
with  which  to  back  up  their  ventures. 

Should  a  time  come,  as  is  occasionally  the  case,  when 
bankers  exhibit  a  spirit  of  undue  optimism,  reflecting  a 
speculative  tendency  on  the  part  of  the  community,  there 
will  be  danger  of  an  over-extension  of  loans,  which  is 
usually  indicated  by  the  growing  deposits  of  the  bank  as 
an  aggregate.  This  may  continue  indefinitely,  inasmuch 
as  a  period  of  the  kind  referred  to  is  usually  a  time  when 
a  spirit  of  over-confidence  is  abroad  and  when,  therefore, 
there  is  little  disposition  to  test  the  ability  of  the  banks 
to  pay  cash.  Unduly  encouraged  by  the  failure  to  draw 
on  them,  banks  in  such  periods  may  continue  adding  to 
their  loans  and  may  thus  pass  the  point  where  experi- 
ence would  indicate  the  desirability  of  restraint.  Such  a 
condition  is  termed  * '  inflation, ' '  and  is  frequently  accom- 
panied by  high  prices  throughout  the  mercantile  com- 
munity due  to  the  use  of  the  bank  credit  or  deposits  in 
purchasing  goods,  employing  labor,  and  carrying  on 
business  operations  in  general. 

A  period  of  contraction  is  the  reverse  of  this  state  of 
affairs,  and  is  usually  seen  when  loans  are  shortened. 


60  American  Banking 

either  through  fear  on  the  part  of  bankers  or  through 
conservatism  on  the  part  of  borrowers  who  see  no  pros- 
pect of  employing  the  loans  profitably.  In  such  a  case, 
there  is  a  tendency  for  the  stock  of  coin  and  currency  in 
the  vaults  of  the  bank  to  increase  far  beyond  what  it 
would  normally  be,  for  the  reason  that,  as  the  outstand- 
ing volume  of  deposits  declines,  the  individuals  who  hold 
the  title  to  them  are  fewer  (or  at  all  events  control  a 
smaller  amount  of  the  claims  against  the  banks)  and 
hence  are  not  able  to  draw  out  the  cash  as  rapidly  as 
otherwise. 

''Idle  money"  tends  to  make  bankers  feel  more  ready 
to  increase  their  loans  at  the  first  favorable  opportunity, 
and  thus  in  the  banking  community  generally  there  is 
a  backward  and  forward  movement  around  a  point  of 
stability  which  represents  the  normal  relationship  of 
the  business  community  to  the  bank  in  respect  to  exten- 
sions of  credit.  This  normal  point  may  be  different  in 
different  countries  and  may  vary  from  one  period  to 
another,  depending  upon  a  variety  of  conditions  some  of 
which  we  have  already  sketched. 

Volume  of  Deposits 

It  is  worth  while  to  note  the  total  amount  of  deposit 
credits  existing  in  various  classes  of  banks  in  the  United 
States.  Such  a  showing  is  presented  in  the  accompany- 
ing table.  The  amount  of  deposits  carried  by  a  given 
class  of  banks  may,  however,  be  widely  different  from 
that  allowed  by  another  class,  for  banks  vary  greatly 
in  respect  to  the  relationship  between  their  outstanding- 
deposits  and  their  other  classes  of  liabilities.  The  class 
of  liability  which  should  be  studied  in  close  relationship 
to  the  deposit  is  the  bank-note. 


Bank  Deposits  61 


Number  of  Individual 

Year  banhs  Loans*  Resources  Capital  deposits 

1907      19,74fi  $10.763. 9t  $19,645.01  $l,690.8t  $13.099.6t 

1908      21.346  10.438.0  19.583.4  1.757.2  12.784.5 

1909      22.491  11.373.2  21,095.0  1,800.0  14,035.5 

1910      23,095  12.521.8  22,450.3  1,880.0  lo.2§3i.4 

1911      24,392  13,346.4  23,631.1  1,952.4  15,908.3 

1912      25.193  13.953.6  24,986.6  2,010.8  17.024.0 

1913      25,993  14,626.7  25,712.2  2,096.8  17,475.7 

1914      26,765  15,339.3  26,971.4  2,132.1  18,517.7 


*  Includes  oTerdrafts. 
t  In  mlUious  of  dollars. 


Inter-Bank  Deposits 


Just  as  an  individual  may  obtain  a  credit  with  a  bank 
by  making  a  ''deposit"  with  that  bank,  so  a  bank  may 
obtain  a  credit  with  another  bank  by  making  a  deposit 
with  that  other  bank.  Such  action  may  be  taken  by  a 
bank  for  any  of  the  reasons  which  impel  an  individual  to 
secure  a  deposit  credit  with  a  bank.  That  is  to  say,  it 
may  have  spare  or  idle  funds  on  hand  which  it  does  not 
want  to  use  immediately  and  which  it  deposits  in  a 
better-equipped  bank  merely  for  safe-keeping.  Or  it 
may  have  funds  that  it  desires  to  place  where  they  will 
bring  in  a  small  interest,  instead  of  keeping  them  idle  in 
its  own  vaults.  Or  it  may  feel  that  a  deposit  credit  with 
another  bank  which  can  be  drawn  upon  will  be  serviceable 
or  desirable  in  its  own  business. 

The  two  last-mentioned  reasons  for  inter-bank  deposits 
are  the  ones  that  have  controlled,  usually,  the  growth  of 
such  deposits.  Such  deposits  are  found  in  those  cases 
where  banks  are  organized  separately  from  one  another, 
and  the  systematic  making  of  such  deposits  tends  to 
place  the  reserve  money  of  the  country  in  a  compara- 
tively small  number  of  strong  institutions.  Where  a 
system  of  powerful  banks  with  many  branches  exists, 
inter-bank  deposits  of  this  kind  are  less  necessary  and 
far  less  numerous. 

The  National  Bank  Act  recognized  the  necessity  of 
such  inter-bank  deposits  by  authorizing  country  banks 
to  deposit  three-fifths  of  their  reserve  funds  with  banks 


62  American  Banking 

in  reserve  cities,  and  banks  in  reserve  cities  to  deposit 
one-half  of  their  reserve  funds  with  banks  in  central 
reserve  cities,  the  last-named  class  being  required  to 
maintain  25  per  cent  of  their  deposit  liabilities  on  hand 
in  currency.  In  this  way,  the  massing  of  the  funds  of 
the  country  in  reserve  and  central  reserve  cities  was 
brought  about.  As  there  are  but  three  central  reserve 
cities,  a  very  decided  degree  of  centralization  was  pro- 
duced. 

The  national  banks  thus  re-deposited  their  reserves 
partly  in  order  to  earn  an  interest  upon  them,  but  even  if 
no  such  interest  were  paid  there  would  be  a  very  sub- 
stantial volume  of  such  inter-bank  deposits  for  the  reason 
already  mentioned — that  a  bank  may  need  a  deposit  with 
another  bank  in  order  to  facilitate  its  business.  Banks 
standing  in  this  relation  to  one  another  are  called  '' cor- 
respondent'-' banks,  the  depository  or  the  depositing 
bank,  indifferently,  being  referred  to  as  the  correspondent 
of  the  other.  This  system  is  now,  of  course,  in  process 
of  modification,  it  being  required  under  existing  law 
that  the  federal  reserve  banks  supersede  the  large  indi- 
vidual national  banks  as  holders  of  the  concentrated 
reserves  of  the  nation. 

TEST  QUESTIONS 

1.  Explain  the  three  typical  methods  by  means  of  which  a 
deposit  may  be  made  at  a  bank. 

2.  Explain :    ' '  The  bulk  of  deposits  are  credit  deposits. ' ' 

3.  Explain  why  it  is  that  a  loan  and  a  deposit  may  be  essen- 
tially alike. 

4.  How  does  the  question  of  reserves  affect  the  subject  of 
deposits  1 

5.  What  does  a  general  rise  in  the  amount  of  deposits 
indicate  ? 


Bank  Deposits  63 

6.  What  does  it  indicate  if  it  takes  place  at  one  particular 
bank  only? 

7.  Explain  how  periods  of  expansion  and  of  contraction  in- 
fluence bank  deposits.  When  do  deposits  rise,  and  when  do  they 
fall? 

8.  What  are  inter-bank  deposits?  What  economic  use  do 
they  serve? 

9.  What  were  the  provisions  of  the  National  Bank  Act  con- 
cerning inter-bank  deposits  of  national  banks? 


CHAPTER  VI 
domestic  exchange 

*' Exchange"  Function 

Why  does  any  bank  need  a  deposit  with  another  bank 
in  the  course  of  its  business?  It  may  need  it  simply  for 
the  sake  of  convenience — that  is  to  say,  in  order  that  the 
bank  with  which  it  deposits  may  be  able  to  redeem  notes 
or  cash  checks  drawTi  upon  the  bank  which  makes  the 
deposit.  Both  of  these  functions  may  be  performed  by 
the  correspondent  bank  or  by  a  federal  reserve  bank 
under  the  new  system. 

But,  besides  these  ser^dces,  the  correspondent  or 
reserve  bank  may  perform  another  service  known  as 
that  of  '' exchange. "  Thus :  A  in  New  Orleans  may  have 
bought  a  bill  of  goods  of  B  in  New  York.  He  wishes  to 
pay  B  but  he  has  no  account  with  a  New  York  bank.  He 
may  send  B  a  check  on  his  New  Orleans  bank  in  which 
case  B  would  have  to  have  it  collected.  But  B  may  exact 
payment  in  ''New  York  funds" — that  is  to  say,  he  may 
insist  (or  it  may  be  a  part  of  the  original  agreement) 
that  he  shall  be  paid  in  funds  that  are  immediately 
available  in  New  York.  A  can  make  such  payment  by 
packing  coin  and  currency  to  the  desired  amount  and 
shipping  it  to  B — a  means  of  payment  sometimes  resorted 
to.  Or  A  might  find  another  individual,  C,  who  had  a 
claim  falling  due  in  New  York.  He  might  induce  C  to 
make  this  claim  over  to  him  and  (supposing  it  was  equal 
to  the  debt  he  owed  to  B)  he  could  in  turn  make  it  over  to 

64 


Domestic  Exchange  65 

B  who  would  then  collect  it  from  the  man  who  owed  it 
in  New  York  and  whom  we  may  call  D.  This  would 
obviate  the  necessity  of  sending  either  coin  or  currency 
from  New  Orleans  to  New  York.  Debts  would  be  offset 
against  one  another  and  that  would  be  the  end  of  the 
matter.  But  evidently  such  a  process  of  matching  or 
offsetting  debts  and  claims  would  be  very  difficult  to  carry 
out  in  the  way  indicated.  It  is  much  simpler  to  transact 
such  operations  through  the  banking  mechanism  of  the 
country  and  thus  the  banks  perform  their  exchange 
function. 

Mechanism  of  Exchange 

In  practice,  up  to  the  present  time,  if  A  wanted  to 
pay  B  he  would  not  search  for  C  but  would  go  direct  to 
his  bank  and  ask  for  a  ''New  York  draft"  or  for  "New 
York  exchange"  to  the  amount  desired.  Then  he  would 
hand  the  bank  his  own  check  upon  it  and  the  bank  would 
hand  him  a  "draft"  on  a  New  York  bank  for  an  equal 
amount.  For  this  service,  it  would  probably  charge  him 
a  small  sum  known  as  ' '  exchange. ' ' 

Evidently,  if  a  great  many  people  came  to  the  bank 
and  made  demands  of  this  kind,  the  bank  would  con- 
stantly have  to  replenish  its  account  with  its  New  York 
correspondent,  unless  it  were  willing  to  see  the  credit 
exhausted.  But  in  practice  the  bank  might  receive  just 
about  as  many  claims  on  New  York  as  it  drew  checks 
against  New  York.  Thus  C  might  be  paid  by  his  New 
York  debtor  with  a  check  on  a  New  York  bank  and  might 
deposit  this  with  the  same  bank  which  had  issued  to  A 
the  draft  on  New  York.  In  that  case  the  bank  could  send 
the  check  deposited  by  C  to  its  correspondent  in  New 
York,  who  would  credit  it  and  collect  the  amount.  Then 
the  bank  would  have  made  a  profit  on  the  two  operations 


66  American  Banking 

equal  to  the  amount  that  it  charged  A  for  the  draft  in 
the  first  place  (less  of  course  the  cost  of  clerk  hire  and 
correspondence).  It  would  also  have  met  the  convenience 
of  two  customers,  and  would  thereby  have  helped  in 
extending  its  business. 

If  such  transactions  did  not  exactly  balance,  the  bank 
might  ultimately  have  to  ship  some  currency  or  to  buy 
exchange  from  someone  who  had  a  credit  in  New  York. 
This  would  be  an  additional  element  of  cost,  but  of  course 
it  would  be  far  less  than  if  the  currency  had  to  be  shipped 
in  every  transaction.  There  are  other  ways  in  which 
the  bank  might  increase  its  credit  with  its  correspondent 
in  New  York.  It  might  discount  paper  payable  in  or  near 
New  York,  and  then  send  such  paper  to  its  correspondent 
bank  for  collection,  the  proceeds  to  be  credited  to  its 
account.  Whatever  methods  were  adopted,  the  net  result 
would  be  the  settlement  or  payment  of  the  claims  of  the 
community  for  goods  shipped  to  different  parts  of  the 
country. 

The  inflow  and  outflow  of  money  in  any  given  com- 
munity must  in  the  long  run  equal  each  other.  In  an 
agricultural  section,  for  example,  when  crops  are  good 
and  prices  high  the  inflow  of  money  will  be  large  and  the 
purchasing  power  correspondingly  great.  These 
increased  purchases  again  result  in  a  larger  outflow  of 
money.  Perhaps  some  of  the  outflow  will  consist  of  paid- 
off  loans,  thus  reducing  the  net  indebtedness  of  the  com- 
munity. On  the  other  hand,  a  crop  failure  results  in  a 
small  inflow  of  money.  Certain  necessities  must,  never- 
theless, be  purchased,  and  in  order  to  pay  for  them  it 
may  be  necessary  to  borrow  from  outside  sources  so  as 
to  equalize  the  inflow  and  outflow.  Thus  all  sales,  pur- 
chases, traveling  expenses,  freight  charges,  wages,  insur- 
ance premiums  and  payments,  gifts,  taxes,  and  all  other 


I 


Domestic  Exchange  67 

factors  of  commerce  and  gift  combine  to  bring  about  an 
equilibrium  in  exchange  for  each  community. 

Bankers  exercise  a  very  important  control  over  these 
community  operations.  It  is  conceivable  that,  if  the 
total  outflow  for  a  long  time  continued  to  exceed  the 
inflow,  a  town  might  become  completely  exhausted  finan- 
cially ;  in  other  words,  bankrupt.  Bankers  have  no  direct 
control  over  the  purchases  of  their  clients  but  through 
their  ability  to  raise  the  rate  of  exchange  or  stop  it 
entirely  they  can  exercise  a  very  potent  control  over  busi- 
ness operations.  Exchange  charges  are  an  important 
element  in  the  cost  of  doing  business.  By  raising  the  rate 
of  exchange,  profits  are  reduced  or  sales  become  impossi- 
ble and  purchases  decline  in  volume  and  variety  or  cease 
altogether.  These  various  operations  gradually  tend  to 
restore  a  safe  level  in  the  trade  balances  of  such  a  com- 
munity  with  the  outside  world. 

Reasons  for  High  Exchange  Chaeges 

The  fact  that  prior  to  the  Federal  Reserve  Act  there 
was  no  general  system  of  clearance,  has  given  rise  to 
high  exchange  charges.  As  things  stand  today,  a  check 
drawn  by  one  man  on  another  in  the  same  city  is  collected 
without  charge.  If  he  takes  it  to  a  bank  and  deposits  it 
there,  the  bank  pays  the  face  of  it,  and  then  gets  it  back 
through  a  clearing  house  in  which  it  joins  with  other 
banks  who  offset  these  obligations  against  one  another. 
The  bank  with  which  the  owner  of  the  check  deposits  it 
may  have  received  five  hundred  checks  aggregating,  say, 
$10,000;  while  another  in  the  same  city  may  have  five 
hundred  checks  drawn  on  it  but  aggregating  only,  say, 
$9,000.  In  such  an  event,  the  bank  had  to  pay  only 
$1,000  net  in  order  to  square  itself  with  other  banks  of 
the  community,  and  the  cost  to  it  is  nothing  beyond  its 


68  American  Banking 

bookkeeping,  management,  and  clerical  service  involved 
in  the  operation  of  the  clearing  house. 

When,  however,  collection  is  undertaken,  there  is  rea- 
son to  expect  development  of  heavier  charges.  If  the 
customer  presents  a  check  drawn  on  a  bank  in  a  different 
city,  the  bank  which  cashes  the  check  is  theoretically 
obliged  to  transmit  that  check  by  mail  either  to  the  bank 
on  which  it  is  drawn,  or  to  another  bank  in  the  same  city, 
and  then  to  receive  back  the  amount  of  the  remittance  in 
the  form  of  currency,  paying  express  or  postage  charges, 
insurance,  etc.,  and  losing  interest  on  the  funds  during 
the  time  they  are  in  transit. 

It  is  true,  of  course,  that  where  exchanges  are  going 
on  between  two  large  centers  such  as  New  York  and 
Chicago,  the  competition  of  the  banks  secures  rates 
charged  for  exchange  a  good  deal  below  this  estimated 
cost  based  on  the  elements  already  indicated.  If  expe- 
rience has  shown  that  about  as  much  money  is  being  sent 
from  one  community  to  another  as  is  being  received  from 
that  other  community  in  the  course  of  six  months,  com- 
petition among  the  banks  brings  about  an  adjustment 
wherein  the  claims  of  different  individuals  in  the  two 
cities  are  oifset  against  one  another,  and  only  the  net 
balance  is  shipped. 

In  the  long  run,  the  man  who  wants  to  send  most  funds 
from  one  of  these  places  to  the  other,  is  charged  a  rate 
which  is  indirectly  based  upon  the  cost  of  shipping  the 
net  balance  of  funds.  This  fluctuates  from  time  to  time 
because  the  amount  of  the  net  indebtedness  due  from  one 
point  to  the  other  also  fluctuates.  Moreover,  in  sundry 
places  bajiks  have  reached  an  agreement  with  one  another 
to  fix  a  rate  for  such  clearance,  and  thenceforward  such 
a  rate  is  made  arbitrary  and  is  not  allowed  to  fluctuate 
as   net    balances    of   indebtedness    vary.      Competition 


Domestic  Exchange  69 

between  banks  lias  led  to  the  establishment  of  ^*par 
points"  throughout  the  country;  that  is  to  say,  points 
whose  checks  will  be  collected  without  charge  in  order  to 
provide  funds  for  the  purpose  of  managing  the  collection 
of  other  checks  drawn  on  neighboring  points. 

Checks  Treated  as  Cash 

Under  the  check  collection  system  which  has  been  in 
vogue  in  the  United  States  for  many  years,  inter-bank 
claims — that  is,  claims  of  one  bank  upon  another — are 
the  equivalent  of  checks  when  the  bank  which  owes  the 
money  is  solvent.  It  has  therefore  been  customary  under 
the  reserve  system  of  the  United  States  for  reserve- 
holding  banks  to  say  to  others  that  they  would  be  glad  to 
credit  these  others  with  such  checks  as  they  (the  latter) 
might  send  in  to  them  immediately  upon  receipt.  That 
is  to  say,  it  has  been  customary  for  Bank  A  in  New  York 
City  to  give  immediate  credit  to  Bank  B  in  Birmingham, 
Alabama,  for  such  checks  draw^n  on  Bank  X  in  Chicago, 
Y  in  Tacoma,  and  Z  in  Minneapolis  as  B  might  send 
to  A.  Thus  Bank  A  in  New  York  City  practically  under- 
took to  collect  checks  on  X,  Y,  and  Z ;  and  meanwhile  it 
stood  ready  to  pay  to  Bank  B  the  face  value  of  these 
checks  on  demand. 

Of  course,  this  meant  that  Bank  A  lost  the  interest  on 
the  funds  during  the  time  that  it  was  engaged  in  collect- 
ing the  checks  in  question,  and  was  also  obliged  to  carry 
w^hatever  expense  resulted  from  the  collection  process, 
such  as  clerical  hire  and  postage.  These  items  seem  small 
when  figured  for  any  particular  check ;  but  when  fig-ured 
for  the  multitude  of  bank  checks  that  daily  pass  over 
the  counters  of  the  banks  of  the  country,  they  become 
enormous. 

Moreover,  it  is  evident  that  the  practice  of  making 


70  American  Banking 

checks  immediately  payable  at  the  place  where  they  are 
deposited,  has  certain  serious  implications.  It  neces- 
sarily means  that  the  bank  which  undertakes  to  pay  them 
must  have  a  sufficient  simi  in  its  vaults  to  meet  any  pos- 
sible demand  upon  it.  The  same  is  true  with  other  banks. 
This  condition  of  affairs  continues  so  long  as  there  are 
any  checks  outstanding  which  have  not  reached  the  bank 
upon  which  they  are  actually  drawn.  There  is  in  short  a 
so-called  "float"  which  represents  the  volume  of  checks 
afloat  in  the  mails  at  any  time  and  not  liquidated. 

Under  the  existing  system,  moreover,  the  checks  sent 
for  credit  collection  are  constantly  crossing  one  another. 
Bank  A  in  New  York,  for  example,  has  a  check  on  Bank 
B  in  Chicago,  and  mails  it  to  C  in  Chicago  with  instruc- 
tions to  collect  it  of  B.  It  may  easily  happen  that,  at  the 
same  time,  B  receives  a  check  on  A  (in  New  York)  and 
sends  it  to  D  in  New  York  with  instructions  to  collect  it 
of  A.  If  each  of  those  checks  is  supposed  to  be  for  $100, 
it  is  clear  that  during  the  period  of  collection  Banks  A 
and  B  have  each  become  liable  for  the  payment  of  $100 
w^iich  has  not  been  charged  off  against  the  accounts  of 
those  who  originally  drew  the  checks.  There  is  a  fund 
here  of  $200  which  has  to  be  protected  by  a  reserve  suf- 
ficient to  guard  against  demands  for  cash.  It  is  clear  that 
this  situation  has  grown  up  as  a  concomitant  of  the  prac- 
tice whereby  deposits  of  outside  banks  in  certain  cities 
were  allowed  to  count  as  reserves  for  them.  In  fact, 
with  no  central  means  of  collection  and  offset,  this  was 
almost  inevitable. 


Domestic  Exchange  71 

TEST  QUESTIONS 

1.  "What  is  meant  by  the  exchange  function  of  banks? 

2.  Explain :     ' '  The  inflow   and  outflow  of  money  in  any 
given  community  must  in  the  long  run  equal  each  other." 

3.  How  may  bankers  influence  the  inflow  and  outflow  of 
money  in  their  own  community? 

4.  What  factors  determine  the  rate  of  exchange  ? 

5.  How  do  banks  handle   the  exchange   and  collection  of 
checks  sent  to  them  from  various  parts  of  the  country  ? 


CHAPTER  VII 

FOREIGN   EXCHANGE 

Exactly  the  same  kind  of  operation  that  takes  place 
between  two  banks  located  in  cities  in  different  parts  of 
the  same  country,  occurs  between  banks  in  different  coun- 
tries. In  transactions  of  the  latter  kind,  the  operation 
which  we  have  just  described  is  called  "foreign 
exchange. ' '  Its  nature  is  the  same  as  that  of  the  domes- 
tic exchange  operation,  but  it  is  more  complex.  This 
complexity  is  due  largely  to  the  fact  that  different  coun- 
tries usually  have  different  currencies,  and  that  therefore 
one  currency  has  to  be  estimated  in  terms  of  another. 
For  example,  A  buys  a  bill  of  goods  from  B  in  London, 
and  B  charges  him  £100.  A,  living  in  New  York,  wants 
to  pay  the  £100  but  he  has  only  American  gold.  He  might 
buy  British  gold  and  ship  it  across  the  ocean,  but  in  prac- 
tice he  would  ask  his  bank  to  give  him  a  draft  on  London 
for  £100. 

If  the  bank  were  willing  to  perform  this  service  with- 
out "exchange"  how  much  would  it  have  to  charge  A? 
That  would  depend  upon  the  gold  value  of  the  English 
pound  sterling  measured  in  American  dollars.  If  this 
value  was  $4,86,  the  bank  would  have  to  charge  A  $486. 
That  is  to  say,  it  would  get  $486  in  gold  or  the  right  to 
demand  from  some  bank  $486  in  gold  or  its  equivalent, 
and  it  would  give  A  the  right  to  demand  £100  in  London 
and  he  would  send  this  draft  to  his  creditor,  who  would 
present  it  for  cashing  at  the  banlc  on  which  it  was  drawn 

73 


Foreign  Exchange  73 

or  would  deposit  it  at  his  own  bank.  As  a  matter  of 
fact,  of  course,  the  bank  would  not  perform  the  service 
gratuitously.  This  raises  the  question  how  much  it  can 
and  ought  to  charge  A  for  the  draft.  Evidently  if  A 
shipped  the  gold  to  London,  he  would  have  to  pay  some- 
one who  owned  English  sovereigns  at  least  their  gold 
equivalent  in  American  money.  Then  he  would  have  to 
pay  transportation  charges,  marine  insurance,  etc.,  and 
he  would  have  to  lose  the  interest  on  the  gold  while  it 
was  in  transit.  Supposing  that  the  sum  total  of  these 
expenses  averaged  3  cents  per  pound  sterling,  A  could 
evidently  better  afford  to  pay  the  bank  anything  up  to 
$4.89  rather  than  engage  in  the  exchange  business  him- 
self. 

There  would  be  a  good  many  Englishmen  desirous  of 
getting  claims  on  New  York  in  order  to  pay  their  debts 
there  and  consequently  a  certain  amount  of  offsetting  of 
debts  would  take  place  even  if  the  bank  declined  to  fur- 
nish exchange  cheaper  than  the  individual  could  actually 
send  his  gold.  The  result  would  be  the  creation  of  an 
exchange  market  which  would  establish  a  rate  of  exchange 
at  which  persons  having  claims  on  London  were  willing 
to  sell  them  in  New  York  and  persons  having  claims  on 
New  York  were  willing  to  sell  them  in  London.  This  is 
exactly  what  occurs  through  the  banking  mechanism  of 
the  country,  the  so-called  ''rate  of  exchange"  being 
determined  by  a  comparison  of  the  debts  due  by  and  to  a 
given  country. 

In  this  exchange  market  the  indebtedness  of  any  given 
country  is  estimated  not  as  compared  with  any  other  one 
country  but  with  the  commercial  world  as  a  whole.  It 
may  be  that  a  given  country  at  a  certain  moment  is  heav- 
ily in  debt  to  another  while  others  are  heavily  indebted  to 
it  and  to  the  second  country.     In  that  case  it  may  be 


74  American  Banking 


FlISrANCING   FOKEIGN   TrADE 

It  has  been  a  subject  of  complaint  for  a  long  time  that 
the  foreign  trade  of  the  United  States  was  inadequately 
financed.  National  banks  not  being  permitted  under  the 
old  law  to  establish  branches  abroad,  it  was  felt  that  in 
many  cases  Americans  doing  a  foreign  business  could 


\ 


able  to  offset  its  debts  against  one  another.  Or  such  a 
countiy  may  be  indebted  to  another  country  but  there 
may  be  a  moral  certainty  that  the  indebtedness  will  swing  :  tw 
the  other  way  before  long.  In  that  case  the  creditor 
country  may  be  induced  to  carry  along  the  indebtedness 
for  a  few  weeks  or  months,  in  consideration  of  a  proper 
interest  payment,  knowing  as  it  does  that  the  debt  thus 
created  will  be  offset  before  long.  The  cost  of  tiding 
over  a  temporary  indebtedness  in  this  way  of  course  adds 
to  the  cost  of  exchange.  In  the  long  run,  however,  a 
country  has  to  send  abroad  as  much  as  it  gets  from 
abroad  or  else  ship  the  difference  in  coin  or  in  titles  to 
local  wealth,  such  as  stocks  and  bonds. 

Everything  that  goes  to  make  up  the  so-called  '' bal- 
ance of  trade"  of  a  country  engaged  in  business  with 
other  countries,  influences  the  amount  that  is  due  by  or  to 
it  and  thereby  affects  the  price  of  exchange  temporarily 
or  in  the  long  run.  Among  a  country's  exports  are  not 
only  goods  but  the  services  it  performs  for  others,  such 
as  ocean  freights,  and  the  securities  it  sends  abroad. 
Among  its  imports  are  not  only  the  goods  it  receives  but 
tlie  services  rendered  to  it,  such  as  the  entertainment  of 
its  tourists  abroad.  Americans  annually  spend  large 
sums  in  foreign  travel  and  this  affects  the  balance  of 
trade,  their  satisfaction  in  travel  being  properly  consid- 
ered an  import  while  the  money  they  spend  is  so  much 
coin  or  credit  exported. 


Foreign  Exchange  75 

not  get  the  accommodation  to  which  they  were  entitled. 
It  was  asserted  that  in  those  countries  where  the  foreign 
trade  of  the  United  States  was  still  limited  in  amount  and 
undergoing  development,  subject  to  more  or  less  severe 
competition,  the  problem  of  securing  adequate  funds 
for  the  trade  was  particularly  difficult. 

This  state  of  affairs  was  fully  recognized  throughout 
the  later  years  of  the  discussion  of  banking  legislation. 
In  the  bill  proposed  by  the  National  Monetary  Commis- 
sion (the  ''Aldrich  Bill"),  provisions  were  embodied 
under  which  a  certain  number  of  national  banks  might 
combine  to  establish  a  bank  whose  function  was  to  be 
solely  that  of  financing  foreign  trade,  and  which  was  to 
be  authorized  to  establish  branches  in  foreign  countries 
as  desired.  The  thought  underlying  this  provision  was 
that,  if  banks  were  permitted  to  join  in  establishing  other 
banks  for  the  creation  of  branches,  small  banks  would  be 
enabled  to  get  the  advantages  of  the  provision  by  unit- 
ing their  efforts  with  those  of  others.  If,  however,  the 
permission  to  create  branches  must  be  confined  to  a  single 
banking  institution,  it  would  be  requisite  to  insist  that 
this  institution  possess  a  very  substantial  capital,  which 
would  necessarily  mean  that  only  a  relatively  small  num- 
ber of  large  banks  would  be  likely  to  go  into  foreign 
fields  and  establish  branch  banks  of  their  own.  This 
latter  view  was  undoubtedly  sound  so  far  as  related 
to  the  establishment  of  a  network  of  branch  banks 
abroad ;  but  it  is  clear  enough  that  there  are  many  banks 
in  the  United  States  whose  capital  is  ample  to  enable 
them  to  establish  a  few  branches  abroad  if  their  business 
interest  is  such  as  to  require  it. 

When  the  Federal  Reserve  Act  was  under  considera- 
tion, it  was  at  first  thought  that  the  plan  of  joint 
association  of  banks  for  the  establishment  of  branches 


76  American  Banking 

would  be  the  more  desirable  provision,  but  subsequently 
this  view  was  abandoned,  and  in  the  final  Act  a  provi- 
sion was  made  permitting  all  national  banks  having  a 
capital  and  surplus  of  not  less  than  $1,000,000  to  estab- 
lish foreign  branches.  It  was  left  to  the  Federal  Reserve 
Board  to  determine  by  regulation  about  how  much  cap- 
ital should  be  allotted  to  such  branches,  and  what  should 
be  the  conditions  surrounding  their  establishment.  This 
provision  was  ultimatelj-  adopted  with  little  change,  and 
now  cons^titutes  Section  27  of  the  Federal  Reserve  Act. 
The  organization  of  the  Federal  Reserve  Board  made  it 
possible  for  national  banks  to  make  application  for  the 
privilege  of  establishing  branches,  and  to  undertake  this 
work  actively,  but  prior  to  July  1, 1915,  only  two  national 
banks  had  applied  for  and  received  permission  to  estab- 
lish such  branches.  Of  these  two,  but  one  undertook  the 
task  upon  a  large  scale  ^dth  an  evident  view  to  doing  a 
broad  commercial  business. 

FoREiGiSr  Trade  Acceptances 

The  Federal  Reserve  Act,  however,  approached  the 
question  of  financing  foreign  trade  not  only  from  the 
standpoint  of  the  machinery  involved,  but  also  from  that 
of  practical  business  methods.  It  is  well  known  that 
foreign  business  generally  is  transacted  upon  the  basis 
of  standard  paper  known  as  "acceptances."  The 
National  Bank  Act,  however,  never  legalized  the  use  of 
acceptances,  and  they  have,  therefore,  been  regarded  as 
a  prohibited  t}^e  of  paper.  The  result  is  that  they  have 
not  figured  to  any  great  extent  in  American  banking 
practice.  There  was  nothing  to  prevent  State  banking 
laws  from  providing  for  the  use  of  acceptances,  but  such 
laws  have  usually  been  modeled  upon  the  National  Bank 
Act,    and   have,    therefore,   been   accustomed   either   to 


Foreign  Exchange  11 

ignore  the  acceptance  question  or  to  prohibit  this  form 
of  paper. 

We  have  already  considered  the  acceptance  when  dis- 
cussing commercial  paper,  but  at  this  point  it  is  neces- 
sary to  examine  the  special  relationship  of  this  form  of 
loan  to  foreign  trade.  The  Federal  Reserve  Act  pro- 
vides that  any  national  bank  may  accept  paper  growing 
out  of  actual  commercial  transactions  involving  the 
importation  or  exportation  of  goods,  and  having  not 
more  than  six  months  to  run;  while  it  also  authorizes 
federal  reserve  banks  to  rediscount  such  acceptances 
when  indorsed  by  member  banks,  or  to  buy  them  in  open 
market  whether  with  or  without  the  indorsement  of  mem- 
ber banks.  Emphasis  should  be  placed  upon  the  fact 
that  this  type  of  paper  is  limited  to  actual  operations 
involving  foreign  shipments  of  goods. 

How  this  provision  bears  especially  upon  financing  our 
foreign  trade,  and  what  are  its  important  indirect  effects 
upon  banking  and  commercial  operations  generally  may 
be  understood  from  a  brief  re\iew  of  foreign  trade 
methods.  In  trade  between  foreign  countries,  the  method 
of  procedure  is  somew^hat  as  follows:  A  merchant,  A, 
in  Buenos  Aires,  ships  coffee  to  B  in  Liverpool.  It  is 
agreed  that  B  will  accept  the  draft  accompanying  the 
coffee  at  90  days '  sight.  It  may  be,  however,  that  A  when 
shipping  the  coffee  desires  to  arrange  for  a  credit  that 
will  enable  him  to  liquidate  very  promptly.  He  may, 
therefore,  have  agreed  with  B  that  his  draft  for  the 
coffee  shall  be  accepted  by  a  Liverpool  bank.  This  bank 
is  induced  by  B  to  agree  to  accept  the  draft  when  it  is 
presented.  B  may  protect  the  bank  in  some  special  man- 
ner if  the  institution  demands  such  action,  or  he  may 
simply  have  made  a  satisfactory  statement  and  showing 
to  the  bank  so  that  that  institution  is  willing  to  accept 


78  American  Banking 

the  draft  in  consideration  of  a  moderate  commission  or 
discount  paid  it  by  B  for  the  ser\dce.  When  it  has  thus 
accepted  the  draft,  that  is,  agreed  to  pay  it  at  maturity, 
the  paper  becomes  the  obligation  of  a  bank  of  known 
standing,  and  is,  therefore,  very  readily  salable  to  some 
other  bank.  The  discount  on  it  will  consequently  be  very 
low,  and  the  original  drawer  of  the  draft  will  be  able  to 
get  his  money  immediately  with  very  little  sacrifice. 
This  means  that  he  can  sell  very  much  more  closely  than 
would  otherwise  be  possible,  because  he  knows  that  he 
"v\ill  lose  very  little  money  in  the  form  of  discount  or 
interest. 

Older  Modes  of  Financing 

With  this  type  of  transaction  may  be  contrasted  the 
earlier  methods  of  financing  foreign  trade  in  the  United 
States.  Suppose  that  A,  in  London,  has  sold  woolen 
goods  to  B  in  New  York.  B  may  agree  to  accept  the 
draft  of  A  and  may  do  so;  but  under  the  pre^'iously 
existing  law,  he  has  been  unable  to  get  a  bank  to  accept 
for  him.  This  meant  that  a  different  method  of  financing 
was  usually  provided  for.  A  would  borrow  from  his  own 
bank,  giving  his  own  note  for  the  period  for  which  he 
wished  to  have  accommodation.  Then,  when  the  draft 
was  presented,  he  would  pay  it  off  with  the  funds  placed 
to  his  credit  in  his  bank;  or  if,  say,  a  90-day  credit  had 
been  extended  to  him,  he  would  wait  until  maturity  and 
then  satisfy  the  claims  of  his  creditors  out  of  the  funds 
that  he  happened  to  have  in  hand,  or  if  necessary  from 
the  proceeds  of  the  loan  obtained  from  his  bank. 

Both  these  methods  were  expensive.  In  case  he 
borrowed  the  money  from  his  bank  with  which  to  meet 
the  draft,  he  had  to  pay  such  rates  of  interest  as  the  bank 
might  exact.     Probably  very  little  competition  would  be 


I 


Foreign  Exchange  79 

felt — certainly  that  would  be  the  case  in  many  instances. 
If  he  simply  waited  until  the  maturity  of  the  draft  before 
making  payment,  he  was  of  course  obliged  to  pay  a  higher 
price  for  his  goods  in  order  to  enable  the  seller  to  realize 
sufficiently  to  carry  the  loan  himself.  In  other  words, 
the  lack  of  the  banker's  acceptance  has  rendered  the 
financing  of  foreign  trade  a  good  deal  more  costly  for 
American  exporters  and  for  the  banks  on  which  they 
depend  than  for  the  exporters  of  any  other  country. 

It  was  this  situation  that  the  provision  of  the  Federal 
Reserve  Act  was  designed  to  correct;  and  of  course  it 
was  only  logical  that  the  paper  thus  legalized  for  national 
banks  should  likewise  be  rendered  eligible  for  rediscount 
at  federal  reserve  banks.  The  fact  that  it  had  been  made 
eligible  in  that  way  naturally  gave  it  a  much  higher 
degree  of  liquidity  than  it  would  otherwise  have  had. 

Movements  of  Money 

It  is  evident  that  there  are  periodic  movements  of 
money  between  countries,  or  different  cities  of  one  coun- 
try, so  that  while  there  may  be  a  balance  against,  (say) 
the  United  States  during  the  late  spring  and  early  sum- 
mer months,  this  will  be  liquidated  during  the  late 
summer  and  early  autumn,  when  staple  products  such 
as  wheat,  cotton,  and  the  like,  are  shipped.  During  the 
intervening  period,  when  a  heavy  balance  is  owing,  the 
banks  will  be  preparing  themselves  to  meet  the  obliga- 
tions, and  instead  of  shipping  cash  will  be  carrying  the 
funds  in  the  form  of  investments  in  paper. 

Then  too,  when  the  banks  of  any  country  have  a  sur- 
plus of  actual  cash  funds  as  a  result  of  hea^y  shipments 
to  them  from  other  countries,  they  are  under  the  neces- 
sity of  employing  them,  pending  the  time  when  they  will 
be  called  for  by  their  owners.    In  the  United  States,  a 


80  American  Banking 

surplus  which  is  carried  in  this. way  is  likely  to  be  invested 
in  the  fonn  of  call  loans  secured  by  stock  or  bonds,  while 
in  foreign  countries  it  is  likely  to  be  invested  in  bankers' 
acceptances.  We  may  sum  up  the  situation  by  saying  that 
in  modern  trade  there  is  never  a  time  when  trade  between 
countries  is  exactly  stable.  Balances  are  due  from  one 
to  another,  and  they  are  represented  by  the  acceptances 
or  obligations  of  banking  houses,  due  at  specified  dates, 
which  these  houses  stand  ready  to  liquidate. 

The  acceptance  market  abroad  is,  in  a  sense,  the  bal- 
ance-wheel of  foreign  trade,  because  it  represents  the 
factor  which  is  making  for  stability,  and  which  tends  to 
keep  business  in  a  stable,  normal  condition  between  dif- 
ferent countries.  So  long  as  surplus  funds  are  invested 
in  loans  on  stock,  so  long  must  a  country  necessarily  be 
without  the  resources  it  stands  in  need  of  to  meet  any 
sudden  demand  or  claim  upon  it  for  funds  to  liquidate 
international  balances.  So  long  as  the  surplus  is  invested 
in  the  acceptances  of  bankers,  just  so  long  is  it  in  position 
to  meet  obligations  to  foreign  countries  by  offering 
claims  upon  bankers  in  those  countries,  or  upon  bankers 
in  other  countries  with  which  such  creditors  are  engaged 
in  trade.  It  is  an  easy  and  natural  way  of  liquidating 
and  equalizing  international  balances.  For  this  the  Fed- 
eral Reserve  Act  makes  provision  in  the  way  already 
described. 

Loans  in  International  Trade 

In  current  discussions  of  foreign  trade  and  of  the  use 
of  the  acceptance,  it  is  often  assumed  that  foreign  trade 
can  be  financed  simply  as  a  result  of  current  sales  and 
purchases.  From  this  it  might  naturally  be  assumed  that 
if  appropriate  banking  machinery'  is  available  to  carry 
the  trade,  there  will  be  little  difficulty  in  securing  a  satis- 


Foreign  Exchange  81 

factory  development  of  the  business.  This  assumption, 
however,  is  not  in  accord  with  the  facts  of  modern  inter- 
national commerce.  International  trade  is  not  carried 
\  upon  a  money  basis;  in  many  countries  pajanent  for 
large  quantities  of  staple  purchases  is  made  in  the  form 
of  securities  based  on  the  enterprises  in  which  the  goods 
thus  bought  are  employed.  For  example,  shipments  of 
steel  rails  to  China  for  the  construction  of  the  railways 
of  that  country,  have  been  paid  for  in  bonds  which  have 
been  taken  by  banking  concerns  in  the  country  which  sold 
the  rails,  and  then  have  been  transferred  to  the  investors, 
who  in  the  last  analysis  supply  the  money.  Similar 
methods  of  financing  have  been  adopted  in  dealing  with 
Brazil,  and  with  other  South  American  countries  where 
trade  grew  up  on  a  basis  of  borrowed  capital. 

While  trade  between  older  nations,  as  for  example 
France  and  Germany,  is  not  necessarily  founded  upon 
international  loans  of  this  kind,  they  nevertheless  figure 
to  a  considerable  extent.  Capitalists  in  one  country  are 
constantly  looking  for  openings  in  another,  and  a  gen- 
eral interchange  of  securities  has  resulted.  From  this 
it  follows  that,  as  a  rule,  the  country  which  exports  to 
another  is  obliged  to  provide  capital  for  the  development 
of  business  in  that  other.  In  South  America,  for  exam- 
ple, there  wdll  be  little  development  of  American  trade 
unless  the  United  States  is  willing  to  supply  the  capital 
for  the  financing  of  Brazilian  enterprises  on  a  long-time 
basis.  Even  in  those  classes  of  operations  which  are  not 
founded  on  bonds,  it  is  frequently  necessary  that  banks 
shall  stand  ready  to  finance  the  trade  by  carrying  the 
merchants  who  are  conducting  it  during  a  crop  period, 
instead  of  expecting  to  be  paid  immediately  upon  arrival 
of  the  goods.    In  other  words,  baulking  operations  are 


82  American  Banking 

not  exclusively  of  a  banking  nature,  but  are  also  financial 
in  the  larger  sense  of  the  term. 

Another  aspect  of  the  same  situation  which  deserves 
notice  is  seen  in  the  fact  that  whenever  one  nation  is  in 
the  habit  of  transacting  most  of  its  business  with  another, 
and  particularly  when  it  is  in  the  habit  of  obtaining  its 
capital  from  that  other,  the  currency  of  the  creditor 
nation  becomes  the  standard  of  exchange  on  the  part  of 
the  debtor.  In  those  circumstances  bills  drawn  in  pay- 
ment of  goods  sold  by  a  third  country  are  usually  stated 
in  terms  of  the  currency  of  the  nation  which  occupies 
the  position  of  creditor.  That  is  to  say,  a  Brazilian 
debtor  who  wished  to  pay  for  goods  he  had  bought  in 
New  York,  is  likely  to  remit  a  draft  drawn  on  London  in 
pounds  sterling.  The  business  of  financing  the  trade 
between  the  United  States  and  Brazil  is  in  that  way 
thrown  to  London,  and  the  banker  in  London  gets  his 
profit  from  the  operation  even  though  it  does  not  concern 
English  goods  directly. 

Foreign  Operations  of  Keserve  Banks 

Having  thus  dealt  with  the  general  question  of  foreign 
trade  and  the  way  in  which  the  Federal  Reserve  Act  pro- 
vides the  necessary  mechanism  for  its  conduct,  w^e  must 
say  a  few  words  with  reference  to  the  foreign  operations 
of  the  federal  reserve  banl^s  themselves.  The  Act  grants 
permission  to  federal  reserve  banks  to  establish  agencies 
abroad  wherever  they  think  best.  Thus  far  only  a  few 
such  agiencies  have  been  established.  It  is  not  likely  that 
many  others  will  follow  until  after  the  war.  Ultimately 
it  Avill  fall  to  the  banks  to  handle  the  foreign  exchange 
transactions,  and  to  make  payments  and  collections  in 
foreign  countries,  while  it  will  be  the  part  of  wisdom 
for  the  banks  to  keep  a  substantial  amount  of  their  funds 


Foreign  Exchange  83 

constantly  invested  in  foreign  bills  in  order  that  they 
may  place  their  funds  upon  a  par  in  controlling  the  move- 
ments of  money  and  rates  of  exchange  between  the 
United  States  and  other  countries. 

Some  Conclusions 

The  plain  conclusion  to  be  drawn  from  the  state  of 
things  just  described  is  that  although  the  Federal 
Eeserve  Act  has  provided  the  mechanism  for  conducting 
foreign  trade  by  permitting  the  organization  of  branches 
of  national  banks,  and  although  it  has  furnished  a  means 
for  bringing  the  banking  paper  of  the  United  States  into 
harmony  with  that  of  other  countries  through  the  intro- 
duction of  the  acceptance,  there  is  no  reason  why 
international  banking  should  be  developed  by  Americans 
very  much  more  largely  than  at  present,  pending  the 
time  when  the  United  States  is  ready  to  furnish  the  cap- 
ital that  is  needed  by  business  men  and  producers  in  the 
countries  with  which  trade  is  being  built  up. 

It  should  be  borne  in  mind  that  the  grow^th  of  the 
acceptance  business  in  the  United  States  during  the  past 
few  years  since  the  federal  reserve  system  was  inaugu- 
rated, has  been  somewhat  exotic,  being  the  result  of  the 
desire  to  finance  foreign  orders  through  the  intervention 
of  American  banking  houses.  The  real  test  of  the  power 
or  disposition  of  American  bankers  and  business  men  to 
develop  the  bankers'  acceptance  on  a  permanent  basis, 
will  be  found  when  the  European  war  is  tenninated  and 
a  normal  condition  of  affairs  has  been  restored  in  inter- 
national relations.  The  country  will  then  be  better  than 
it  would  have  been  had  not  war  occurred,  for  the  reason 
that  there  will  be  much  larger  demand  for  American 
capital  and  American  banking  machinery  than  would 
have  been  the  case  under  ordinary  conditions. 


84  American  Banking 

TEST  QUESTIONS 

1.  In  what  regard  does  foreign  exchange  differ  from  domes- 
tic exchange? 

2.  Explain  what  is  meant  by  rate  of  exchange  as  applied 
to  foreign  exchange? 

3.  AVhat  factors  determine  the  rate  of  exchange  in  foreign 
exchange? 

4.  AVhat  items  of  international  trade  enter  into  the  balance 
of  trade  of  a  nation? 

5.  "What  provisions  were  made  in  the  Federal  Reserve  Act 
to  aid  American  banks  in  financing  foreign  trade? 

6.  What  are  foreign  trade  acceptances? 

7.  Explain  in  detail  just  how  an  exporter  would  use  for- 
eign trade  acceptances  in  financing  his  operations? 

8.  What  part  do  international  loans  play  in  the  develop- 
ment of  foreign  trade  ? 

9.  How  is  the  subject  of  international  loans  related  to  the 
foreign  trade  problems  of  the  United  States  ? 

10.     How  are  branch   banks   and   foreign  agencies  used  in 
financing  foreign  trade? 


CHAPTER  VIII 
bank  notes 

Nature  of  the  Note 

Thus  far  "deposits"  have  been  spoken  of  as  if  they 
were  the  sole  form  in  which  a  bank's  loans  could  be 
granted.  This  mode  of  treatment  was  adopted  because 
the  deposit  is  the  chief  means  of  extending  credit  in  the 
United  States  today.  But  it  should  be  borne  in  mind  that 
it  is  not  the  sole  means.  As  seen  in  another  chapter,  the 
note  is  a  co-ordinate  means  of  extending  credit.  It  is, 
in  fact,  a  means  which  came  into  general  vogue  much 
earlier  than  the  deposit  but  has  been  displaced  in  certain 
directions  because  of  the  greater  convenience  of  the 
latter. 

There  has  been  a  very  general  failure  in  popular  dis- 
cussion of  banking  to  recognize  the  identity  of  the  note 
and  the  deposit  so  far  as  they  relate  to  the  bank  itself. 
There  may  be  a  difference  of  opinion  about  the  compara- 
tive effects  of  notes  and  deposits  upon  the  level  of  prices 
and  the  general  business  of  the  community,  but  none 
about  their  relationship  to  the  bank.  If  the  borrower 
presents  himself  at  a  bank  for  accommodation,  has  his 
security  accepted,  and  his  loan  granted,  there  is  no  the- 
oretical difference  so  far  as  the  bank  is  concerned  whether 
it  credits  him  with  $1,000  on  its  books  and  allows  him  to 
draw  it  out  at  pleasure  or  to  transfer  it  to  others,  or 
whether  it  hands  him  a  package  of  one  thousand  demand 
notes  which  he  may  present  at  sight  for  payment  or 

85 


86  American  Banking 

which  he  may  hand  to  one  thousand  other  persons  who 
may  present  them  if  they  choose.  Whether  the  bank  has 
credited  the  borrower  with  $1,000,  or  has  given  him  one 
thousand  demand  notes  (or  ''bank  notes"),  it  is  in 
exactly  the  same  position  so  far  as  the  outside  world  is 
concerned — that  is  to  say  it  has  accepted  the  borrower 's 
note  for  $1,000  and  in  return  has  given  him  a  sight  claim 
for  $1,000  upon  itself,  the  consideration  being  a  rate  of 
interest  of  specified  amount.  The  bank  note  must  there- 
fore be  looked  upon  from  the  standpoint  of  banking  just 
as  is  the  bank  deposit — as  a  sight  liability. 

Relation  of  Notes  to  Cueeency 

The  note,  when  once  issued,  differs  from  the  deposit  in 
its  practical  effect  upon  the  bank  only  in  respect  to  the 
time  it  remains  in  circulation.  It  is  plain  that  $1,000  in 
notes  paid  out  by  a  bank  over  its  counter  may  be  almost 
immediately  placed  on  deposit  with  it,  in  which  case  all 
that  has  happened  has  been  that  the  bank  has  exchanged 
one  form  of  liability  for  another  form.  But  such  an  issue 
of  notes  may  remain  in  the  hands  of  indi\dduals  for  a 
great  while.  If  there  is  absolute  confidence  on  the  part 
of  such  individuals  that  the  bank  is  solvent  and  able  to 
pay  its  obligations,  and  if  there  is  a  shortage  of  currency 
in  the  community  so  that  the  bank  notes  fill  a  convenient 
place,  the  life  of  the  notes  may  be  very  long. 

In  the  case  of  the  deposit,  the  existence  of  the  credit 
upon  which  that  deposit  is  based  may  be  equally  long. 
Thus,  if  a  single  bank  does  the  business  of  a  given  com- 
munity and  grants  a  credit  of  $1,000  to  a  borrower,  who 
secures  a  renewal  of  his  credit  from  time  to  time,  it  is 
possible  that  this  credit  may  be  indefinitely  continued 
while  the  claim  on  the  bank  may  be  passed  from  hand  to 
^and  in  the  form  of  checks.    As  a  matter  of  fact,  a  check 


Bank  Notes  87 

does  not  pass  many  times  before  it  is  presented  for 
redemption,  while  the  practice  of  commercial  banks  is 
not  to  grant  too  frequent  or  too  long  renewals  of  credits. 
This  means  that  any  given  draft  upon  a  deposit  is  not 
likely  to  remain  long  in  existence,  while  the  credit  which 
brought  it  into  existence  is  itself  likely  to  be  terminated 
at  a  comparatively  early  day. 

The  same  thing  is  true  of  the  loan  on  the  strength  of 
which  bank  notes  are  issued,  but  the  bank  note  itself  may 
pass  from  hand  to  hand  a  great  many  more  times  than 
Avould  a  check  for  an  equal  amount.  In  other  words,  the 
circulation  activity  of  the  bank  note  is  likely  to  be  very 
much  greater  than  that  of  the  deposit  of  equal  face  value. 
This  means  that  the  bank  note  has  a  somewhat  different 
status  as  currency  from  that  which  is  occupied  by  the 
deposit.  How  far  the  currency  activity  of  the  note  affects 
prices  in  a  way  different  from  the  influence  exerted  by 
the  deposit  need  not  be  discussed  at  this  point,  it  being  a 
problem  of  money  rather  than  of  banking.  The  fact 
remains  that  the  bank  note  performs  a  "currency  func- 
^tion"  which  has  generally  been  considered  more 
important  than  that  of  the  deposit.  If  a  given  volume  of 
bank  notes  is,  on  the  average,  maintained  in  circulation 
in  any  given  country,  such  volume  e\T-dently  displaces  an 
equal  amount  of  some  other  form  or  forms  of  currency  or 
coin.  This  may  be  a  very  desirable  feature  of  the  bank 
note  system,  inasmuch  as  it  substitutes  a  credit  instru- 
ment of  comparatively  low  cost  for  a  high-cost  circulating 
medium  such  as  gold. 

Pkotecting  Notes 

Because  of  this  "currency  function,"  it  has  been  felt 
by  legislators  in  most  countries  that  the  issue  of  bank 
notes  ought  to  be  controlled  with  very  great  care,  and  as 


88  American  Banking 

a  result  numerous  methods  for  restricting  note  issues 
have  been  attempted.  It  has  been  asserted  that  the  use 
of  such  methods  was  necessary  in  order  to  prevent  banks 
from  "over-issuing"  their  notes,  thus  driving  out  the 
metallic  circulation  of  the  country  and  reducing  the  cir- 
culation to  a  paper  basis.  It  has  been  argued  further 
that  inasmuch  as  the  bank  notes  were  likely  to  get  into 
tlie  hands  of  persons  who  had  no  knowledge  of  the  con- 
dition of  the  bank  which  issued  them,  such  persons  were 
entitled  to  greater  safeguards.  Those  who  received 
checks,  it  has  been  stated,  almost  immediately  had  them 
redeemed  in  one  form  or  another,  while  those  who 
received  notes  might  keep  them  a  long  time  under  the 
impression  that  they  were  as  good  as  any  form  of  money. 
For  these  and  other  reasons  the  idea  of  a  special*protec- 
tion  for  bank  notes  has  been  very  generally  accepted. 

Whether  this  idea  is  w^ell  or  ill  founded  need  not  be 
discussed  here ;  the  fact  of  chief  interest  is  that  most  of 
the  banking  systems  of  the  world  provide  such  protec- 
tion. This  protection  may  take,  and  does  in  practice 
take,  several  different  forms.  One  of  the  most  familiar 
forms  is  the  limiting  of  the  total  amount  of  bank  notes 
to  be  issued  by  a  given  institution.  Such  a  limitation 
may  be  based  on  a  lump  sum,  as  seen  for  instance  in 
legislation  that  a  given  bank  shall  not  issue  more  than  a 
specified  amount  of  notes.  More  commonly  it  is  based 
upon  capital  and  may  take  the  form  of  a  provision  that 
no  bank  shall  issue  more  notes  than  are  equal  in  face 
value  to  the  amount  of  its  paid-up  capital. 

A  second  mode  of  protecting  the  note-holder  is  that  of 
setting  aside  a  special  security  for  the  protection  of  notes. 
Thus  banks  may  be  directed  to  invest  in  a  given  kind  of 
bonds  a  sum  equal  to  the  amount  of  the  notes  they  issue. 
This  type  of  control  is  seen  in  the  national  banking  sys- 


I 


Bank  Notes  ■  89 

tern.  Coupled  with  this  (as  seen  in  the  national  banking- 
system)  may  be  a  provision  that  the  notes  shall  be  a  first 
lien  upon  the  assets  of  the  bank  which  issues  them. 

A  third  method  of  protecting  a  note  issue  may  be  the 
flat  guarantee  of  the  government  which  has  chartered  the 
issuing  bank  that  in  the  event  of  the  failure  of  such  bank 
it  will  assume  a  responsibility  for  its  notes. 

A  fourth  mode  of  protection  may  be  found  in  regula- 
tions designed  to  control  the  classes  of  security  which 
shall  be  held  by  banks  behind  their  notes.  Thus  banks 
may  be  directed  not  to  issue  more  notes  than  are  pro- 
tected by  given  classes  of  commercial  security.  This  has 
the  effect  of  limiting  note  issues  beyond  a  certain  point 
to  those  classes  of  loans  in  which  the  specified  kind  of 
security  can  be  obtained. 

A  fifth  mode  of  protection  is  seen  in  the  establishment 
of  peculiar  facilities  for  redemption  of  notes  and  for 
assuring  their  prompt  return  to  the  bank  which  put  them 
out. 

Why  Notes  Are  Issued 

The  issue  of  bank  notes  is  taken  as  so  much  a  matter 
of  course  that  the  reason  for  their  issue  is  not  usually 
considered  in  much  detail.  In  fundamental  analysis,  of 
course,  the  notes  come  out  for  exactly  the  same  reasons 
which  govern  the  creation  of  deposits — someone  secures 
a  loan  from  the  bank,  and  the  credit  corresponding 
thereto  is  granted  in  the  form  of  a  note  issue.  But  this 
does  not  explain  the  selection  of  the  note  as  compared 
with  the  deposit.  There  must  be  some  reason  determin- 
ing whether  a  note  will  be  handed  to  a  borrower  or 
whether  a  credit  of  like  amount  will  be  written  in  a  pass 
book. 

This  is  usually  a  question   of  business  convenience 


90  American  Banking 

merely,  and  as  such  is  to  be  settled  by  the  borrower 
(always  supposing  that  the  bank  is  able  to  issue  the  note 
if  it  chooses,  under  the  existing  law) .  The  borrower  may 
prefer  notes  because  of  their  greater  acceptability  to  the 
person  to  whom  they  are  to  be  paid.  Thus,  laborers 
usually  choose  to  be  paid  in  notes  or  coin  rather  than  in 
checks  because  they  have  difficulty  in  getting  the  checks 
cashed.  In  the  same  way,  an  agricultural  community 
usually  prefers  to  take  its  loans  in  the  form  of  notes, 
because  the  points  at  which  the  notes  are  to  be  paid  out 
are  distant  from  the  bank,  so  that  checks  would  not  be 
very  acceptable.  In  practice,  banks  which  make  loans 
chiefly  in  city  communities  have  little  demand  for  note 
issues,  while  banks  in  rural  communities  can  make  a 
much  larger  use  of  the  notes  and,  granting  that  their 
issue  is  not  made  unduly  expensive,  will  prefer  them  to 
the  credit  deposit. 

The  bank  itself  naturally  prefers  to  see  its  obligations 
remain  outstanding  as  long  as  possible  before  being  pre- 
sented. Evidently  the  longer  a  bank  can  keep  its  notes 
out  before  presentation,  the  longer  does  it  enjoy  the 
interest  upon  the  loan  which  gave  rise  to  these  notes, 
without  having  to  make  any  of  them  good  through 
redemption.  If  the  bank  affords  all  proper  facilities  for 
redemption  and  stands  ready  to  make  the  notes  good 
whenever  they  come  in,  depending  purely  upon  the  habits 
of  the  community  and  its  confidence  in  the  institution  to 
keep  the  notes  outstanding  for  a  time,  the  desire  to  main- 
tain them  ^* alive"  as  long  as  practicable  is  perfectly 
legitimate.  The  condition  is  different  when  the  bank 
resorts  to  improper  methods  for  the  purpose  of  avoid- 
ing redemption.  But,  granting  that  the  redemption  facil- 
ities are  adequate,  tlie  bank  will  naturally  and  properly 
desire  to  keep  its  notes  out  and  will  pay  them  to  such 


Bank  Notes  91 

borrowers  as  are  willing  to  accept  them,  if  it  believes  that 
by  adopting  this  form  of  accommodation  it  can  secure  a 
slightly  longer  life  for  its  credit. 

Note  Inflation 

It  is  on  this  ground  that  the  fears  of  note  inflation  have 
been  fomided.  The  supposition  has  been  that  banks  by 
constantly  making  their  loans  in  the  note  form  could  keep 
outstanding  a  large  volume  of  such  currency,  and  might 
thereby  injuriously  affect  the  composition  of  the  circu- 
lating medium.  This  theory,  of  course,  has  neglected 
entirely  the  fact  that  if  banks  were  required  to  make 
redemption  easy,  and  if  every  proper  inducement  to 
prompt  redemption  were  accorded,  there  could  be  no 
ground  for  expecting  a  note  to  remain  in  existence  longer 
than  a  deposit.  In  other  words,  the  whole  question  of 
inflation,  whether  effected  through  the  excessive  issue  of 
notes  or  by  the  excessive  creation  of  deposits,  is  primarily 
a  question  of  the  judgment  exercised  in  making  bank 
loans  in  the  first  place. 

In  the  second  place,  it  is  dependent  upon  the  action  of 
the  community  itself  in  demanding  redemption.  If  the 
bank  stood  ready  to  grant  loans  upon  inadequate  security 
to  start  with,  and  if,  when  such  loans  had  been  granted, 
the  community  were  willing  to  take  and  keep  the  notes 
in  its  possession  indefinitely,  there  might  be  a  note  infla- 
tion just  as  in  the  case  of  excessive  loans  which  took 
the  form  of  deposit  credits.  Granting  that  the  banks 
exercised  reasonable  prudence  in  making  the  loans  origi- 
nally, the  question  of  note  inflation  would  depend  upon 
whether  or  not  there  was  any  inducement  to  redeem  the 
currency. 

This  raises  the  question  what  it  is  that  actually  pro- 
duces redemption  whether  of  notes  or  deposits.    In  study- 


92  American  Banking 

ing  the  deposit  question,  we  have  seen  that  far  the  larger 
part  of  the  demands  for  coin  or  currency  that  are  pre- 
sented to  the  average  institution  come  from  other  banks 
•and  not  from  the  public.  The  same  thing  is  precisely  true 
of  bank  notes.  Only  a  given  volume  of  transactions  is 
likely  to  be  performed  by  the  agency  of  bank  notes  in  a 
modern  commercial  community.  This  means  that  bank 
notes  v.'hich  are  issued  in  excess  of  that  sum  will  be 
deposited  by  the  holders  with  their  own  institution,  since 
few  i^ersons  in  these  days  are  given  to  the  practice  of 
hoarding,  and  thus  the  responsibility  for  ultimately  pre- 
senting the  notes  for  redemption  at  the  bank  which  issued 
them  will  be  transferred  to  the  institution  with  which 
they  are  deposited.  If  such  institutions  find  it  to  their 
interest  or  profit  to  force  redemption  of  the  notes,  they 
will  do  so.  If,  on  the  other  hand,  there  is  no  reason  why 
they  should  compel  the  redemption  of  notes,  they  will  be 
likely  to  retain  them  and  pay  them  out  over  their  o^\ti 
counters. 

The  whole  Cjuestion  depends  upon  whether  or  not  it  is 
profitable  for  a  bank  to  issue  notes  itself.  If  such  is  the 
case  it  will  not  pay  out  the  notes  of  other  banks,  but  will 
present  them  for  prompt  redemption,  and  when  condi- 
tions permit  or  demand  the  paying  out  of  notes  each  will 
pay  out  its  o^ni  notes.  Under  such  circmnstances,  no 
bank  would  pay  out  the  notes  of  another  bank,  any  more 
than  it  would  grant  a  customer  a  credit  on  another  bank 
instead  of  on  itself. 

Theory  of  Note  Issue 

From  what  has  been  said  it  is  clear  that  the  theory  of 
note  issues  and  their  relation  to  the  bau-k  is  identical  with 
that  of  deposits  and  their  relation  to  the  bank.  There  is 
in  fact  no  distinction  to  be  drawn  in  this  respect  between 


Bank  Notes  93 

the  note  and  the  deposit.  The  putting  out  of  an  issue  of 
notes  will  be  considered  by  the  bank  under  exactly  the 
.same  terms  and  conditions  as  those  which  have  controlled 
it  in  regard  to  the  creation  or  grant  of  a  line  of  deposits. 
The  classes  of  security  accepted  by  the  bank  when  it  is 
asked  to  make  an  issue  of  notes  are  the  same  as  those 
which  it  will  accept  when  granting  a  loan  in  the  form  of  a 
credit  on  its  books.  The  protection  of  the  bank  against 
loss  depends  entirely  upon  the  security  which  it  receives, 
and  the  standing  of  the  borrower  who  gets  the  loan. 
There  is  no  special  profit  in  the  issue  of  notes  that  does 
not  inhere  in  the  creation  of  deposits. 

The  choice  between  the  note  and  the  deposit,  as  has 
already  been  shown,  is  purely  one  of  convenience.  In 
studjdng  note  issues  therefore,  attention  need  not  be 
given  to  any  special  questions  of  bank  loans  or  security. 
The  problem  of  notes  relates  entirely  to  methods  of  con- 
trolling the  issue,  securing  prompt  redemption,  guaran- 
teeing ultimate  soundness,  and  providing  for  universal 
acceptability. 

Redemption  of  Notes 

Probably  the  redemption  of  notes  is  the  most  impor- 
tant of  all  subjects  connected  with  their  use.  It  is  obvious 
that  notes,  like  deposits,  should  be  instantly  redeemed  in 
standard  money  whenever  the  request  is  made  of  the 
bank  which  issues  them.  But,  owing  to  the  wide  field  of 
circulation  which  notes  occupy,  it  has  usually  been  felt 
that  a  good  deal  more  than  this  should  be  attempted.  In 
the  national  banking  system,  redemption  is  carried  on  at 
Washington  by  the  Treasury  Department,  which  uses  for 
this  purpose  a  fund  equal  to  5  per  cent  of  the  notes  issued 
by  each  bank  and  contributed  by  each.  This  fund  is 
deposited  witli  the  Treasury  at  the  time  when  the  notes 


94  American  Banking 

are  taken  out.  Then  if  a  bank  which  holds  the  notes  of 
other  banks  desires  to  secure  redemption,  it  may  send  the 
notes  to  Washington  and  have  them  redeemed  by  the 
Treasury,  which  pays  for  them  out  of  the  5  per  cent  fund 
and  then  requires  the  original  issuer  to  restore  this  fund 
to  its  normal  amount  and  take  the  notes  that  have  been 
thus  redeemed.  The  bank  which  issued  the  notes  is  then 
in  position  to  reissue  the  notes  if  it  desires. 

The  system  works  sufficiently  well  under  the  condi- 
tions to  which  the  national  banking  system  is  subject, 
especially  as  every  national  bank  is  required  to  receive 
the  note  of  any  other  national  bank  on  deposit.  This 
means  that  since  the  national  banking  system  is  very 
widely  diffused,  having  now  over  7,000  members,  and 
since  other  banking  systems  are  so  closely  allied  to  it, 
the  holder  of  a  national  bank  note  is  practically  assured 
of  a  place  near  at  hand  to  which  he  can  resort  with  his 
bank  notes,  deposit  them,  thus  securing  the  claim  upon 
his  local  bank  instead  of  the  note  issued  by  a  distant 
bank,  and  thereby  provide  himself  with  funds  at  his 
pleasure.  Where  notes  are  issued  by  central  banks  with 
branches  it  is  usual  to  have  the  notes  redeemed,  under 
certain  restrictions,  at  those  branches. 

Whatever  the  system  of  redemption  employed  may  be, 
its  uniform  object  is  to  guarantee  to  the  note-holder  the 
power  to  secure  liquidation  of  his  claim  against  the  note- 
issuing  bank  promptly  and  without  expense.  Wherever 
such  conditions  are  assumed,  a  uniform  and  stable  note 
currency  is  the  result.  Such  a  note  currency  may  be 
sluggish  in  redemption  as  in  the  case  of  national  bank 
notes,  or  rapid  and  elastic  as  in  the  case  of  the  Scotch 
bank-note  issues.  In  either  case  the  soundness  and  secur- 
ity of  the  currency  is  assured  and  its  place  as  an  element 


Bank  Notes  95 

in  the  circulating  medium  on  a  parity  with  other  forms 
of  currency  is  understood. 

Ultimate  Security  of  Note  Issues 

The  question  whether  note  issues  should  be  given  any 
ultimate  security  different  from  that  possessed  by  the 
other  liabilities  of  the  bank  has  been  considerably  dis- 
cussed and  opinions  vary  widely  with  reference  to  it. 
Probably  the  best  opinion  of  the  day  is  that  no  such 
special  security  is  desirable,  but  that  the  safety  of  the 
note-holder  is  to  be  provided  for  by  means  of  prompt  and 
active  redemption  and  by  confining  the  issue  of  notes  to 
banks  whose  capitals  are  large  enough  and  whose  meth- 
ods are  sound  enough  to  assure  the  note-holder  and  the 
government  that  there  will  be  a  high  degree  of  respon- 
sibility on  the  part  of  the  institution. 

This  idea  is  carried  a  step  further  when  provision  is 
made  (as  in  the  Canadian  banking  system)  for  making 
the  banks  jointly  liable  for  the  notes  of  all  insolvent 
banks.  In  the  case  of  the  Canadian  banks,  the  result  is 
accomplished  by  compelling  banks  which  desire  to  issue 
notes  to  put  up  a  jointly  contributed  fund  called  a  "guar- 
anty fund ' '  on  which  the  notes  of  any  insolvent  bank  may, 
under  certain  circumstances,  be  made  to  draw.  The 
result  of  such  a  provision  is  to  make  banks  exercise  an 
oversight  over  one  another's  issues  and  to  create  a  prob- 
ably higher  degree  of  watchfulness  than  would  exist  were 
the  banks  severally,  but  not  jointly,  liable  for  the  out- 
standing notes. 

Such  a  system,  however,  is  entirely  different  from  one 
in  which  a  bank  is  compelled,  before  issuing  any  notes,  to 
lay  aside  a  part  of  its  assets  in  a  segregated  fund  for 
the  purpose  of  protecting  the  note  issue  based  thereon. 
This  is  the  system  employed  under  the  National  Bank 


96  AiKericau  Banlxnij 

Act  of  the  present  day  and  has  i)roved  to  be  unsatisfac- 
tory. Every  national  bank  upon  being  organized  was 
originally  required  to  buy  an  amount  of  bonds  depend- 
ent upon  the  amount  of  its  capitalization  and  to  deposit 
these  bonds  in  trust  with  the  Treasurer  of  the  United 
States.  Upon  so  doing,  the  bank  is  permitted  to  receive 
bank  notes  to  an  equal  amount  and  can  then  dispose  of 
these  as  it  pleases,  using  them  in  loans  to  borrowers. 
Should  the  bank  fail,  the  notes  can  be  provided  for  by 
selling  the  bonds  and  thus  establishing  a  fund  for  their 
cancellation.  The  Federal  Reserve  Act  repealed  the  pro- 
vision requiring  such  purchases  of  bonds  by  banks. 

Inasmuch  as  United  States  bonds  have  always  been  of 
high  standing  in  the  market  since  the  system  of  note 
issue  referred  to  was  first  established,  there  has  never 
been  a  time  when  anyone  felt  the  slightest  question 
about  the  ultimate  goodness  of  the  national  bank  note. 
This  very  secure  character  has,  however,  been  obtained 
at  considerable  cost,  since  the  use  of  the  United  States 
bonds  has  rendered  it  very  difficult  to  get  the  notes  into 
circulation  when  they  were  wanted  and  conversely  has 
made  it  hard  to  retire  them  when  they  were  not  wanted. 

Difficulties  of  Bond  Security 

The  difficulties  which  have  grown  out  of  the  bond-secur- 
ity system  under  the  National  Bank  Act  are  of  several 
kinds.  It  is  plain  that,  if  banks  are  required  to  buy 
United  States  bonds  before  they  can  issue  any  notes,  the 
total  amount  of  the  notes  cannot  exceed  the  total  amount 
of  the  bonds.  This  was  not  a  matter  of  importance  so 
long  as  the  bonds  in  existence  were  larger  in  volume  than 
the  notes  that  were  wanted  or  were  likely  to  be  wanted, 
but  as  the  national  banking  system  expanded,  and  as  the 
uses  of  United  States  bonds  in  other  directions  became 


Bank  Notes  97 

more  numerous,  the  margin  of  bonds  that  could  be 
obtained  at  any  given  time  for  the  purpose  of  issuing 
notes  thereon  was  greatly  narrowed.  That  meant  that  it 
at  any  time  there  was  a  sudden  call  for  notes,  they  could 
not  be  issued,  since  the  bonds  could  not  easily  be  had. 

Furthermore,  the  formalities  attending  the  deposit  of 
bonds  with  the  Treasury  and  the  printing  and  transmis- 
sion of  notes  by  the  latter  institution,  have  been  such  as 
to  require  many  days.  About  three  weeks  is  the  time 
needed  by  the  Treasury  and  the  Bureau  of  Engraving 
and  Printing  to  get  out  an  order  of  notes  for  a  bank. 
Few  banks  can  foresee  their  currency  necessities  several 
weeks  in  advance,  and  therefore  it  has  often  happened 
that  when  banks  ordered  notes,  the  notes  were  sent  to 
them  after  their  utility  had  entirely  disappeared,  so  that 
in  many  cases  they  were  sent  back  to  the  Treasury  with- 
out even  opening  the  packages  in  which  they  were 
contained. 

Beside  these  considerations,  it  is  true  that  the  varia- 
tions in  the  price  of  bonds  and  the  rate  of  interest  on 
bonds  now  have  a  more  controlling  influence  in  dictating 
the  issue  of  currency  than  have  the  necessities  of  the  com- 
munity. A  banker  does  not  wish  to  issue  notes,  unless 
such  issue  is  absolutely  indispensable,  except  where  he 
can  earn  a  fair  rate  of  interest  thereon.  Government 
bonds  bear  an  extremely  low  rate  of  interest  and  in  some 
cases  they  command  a  high  premium.  If  a  banker  who 
invests,  say,  $110  in  a  government  bond  of  the  par  value 
of  $100  can  get  only  $100  in  notes,  and  if  the  bond  in 
question  bears  a  rate  of  only  3%  or  4%  interest,  the 
investment  may  not  be  at  all  satisfactory  when  compared 
with  that  which  the  banker  would  make  by  using  his  $100 
as  a  reserve  and  granting  deposit  credits. 

Of  late  years,  the  banks  have  been  enabled  to  get 


98  American  Banking 

United  States  2%  bonds  which  sell  at  about  par,  so  that 
an  investment  of  $100  in  a  2%  bond  will  bring  the  bank 
about  $100  in  bank  notes,  the  margin  due  to  the  premium 
(on  which  no  notes  could  be  obtained)  being  thus  elimi- 
nated. Although  the  rate  of  interest  on  the  two's 
was  so  low,  there  has  been  a  small  profit  in  issuing 
notes  on  these  bonds,  and  the  result  has  been  a  steady 
increase  in  bank  circulation,  the  result  of  which  has  been 
to  '^tie  up"  still  more  of  the  government  bonds  behind 
the  notes.  Conversely  there  has  been  no  inducement  to 
cut  dowTi  the  amount  of  notes  in  circulation  when  the 
currency  needs  of  the  community  fell  off,  and  therefore 
the  circulation  has  remained  more  or  less  inflexible,  gold 
being  exported  when  there  was  more  circulating  medium 
than  was  necessary.  In  other  words,  the  bank  circula- 
tion has  been  'inelastic." 

Federal  Reserve  Notes 

When  the  Federal  Reserve  Act  was  in  process  of  draft- 
ing all  these  considerations  were  taken  under  advisement, 
and  it  was  sought  both  to  provide  for  the  proper  treat- 
ment of  existing  note  currency  as  well  as  for  the  issue  of 
new  notes.  The  Act  provided  for  two  new  classes  of 
currency:  (1)  federal  reserve  notes,  and  (2)  federal 
reserve  bank  notes.  The  former  were  to  be  protected 
by  commercial  paper  of  the  kind  rendered  eligible  for 
rediscount  under  the  terms  of  the  law,  the  latter  by 
national  2%  bonds  purchased  from  the  member  banks  of 
the  system. 

The  ultimate  form  of  the  Federal  Reserve  Act,  how- 
ever, provided  for  the  conversion  of  2%  bonds  into 
3%  bonds  by  federal  reserve  banks,  such  3%  bonds,  how- 
ever, to  lose  their  privilege  of  deposit  to  protect 
circulation;   so   that  under   the   terms   of  the   Federal 


Bank  Notes  99 

Reserve  Act,  the  natural  development  will  be  the  con- 
version in  twenty  years  of  most  of  the  national  bank 
notes  into  federal  reserve  notes  with  some  accompanying 
exemptions  of  these  notes  through  the  conversion  of  the 
2%  bonds  protecting  them  into  3%  bonds;  while  in  the 
meantime,  federal  reserve  notes,  based  on  commercial 
paper,  will  be  issued  from  time  to  time  as  demanded,  in 
quantities  sufficient  to  supply  the  elastic  element  in  cur- 
rency, and  to  fill  up  such  gaps  in  existing  national  bank 
notes  as  might  be  caused  through  the  retirement  of  note 
issues  due  to  the  conversion  of  2%  into  3%  bonds  not 
bearing  the  circulation  privilege. 

Issue  of  Federal  Eeserve  Notes 

Let  us  now  observe  with  some  care  exactly  what  gives 
rise  to  a  demand  for  currency  and  to  consequent  issues  of 
federal  reserve  notes.  When  A  trades  with  B  to  the 
extent  of  $100,000  worth  of  goods,  he  thereby  creates  a 
demand  for  some  means  of  transferring  the  value  of 
$100,000.  This  exchange  may  be  made  by  the  actual  use 
of  money,  or  by  the  drawing  of  a  check.  Where  the  buyer 
of  the  goods  does  not  have  the  means  to  pay  for  them,  he 
usually  applies  to  his  bank  for  accommodation,  and  such 
bank  may  meet  his  requirements  by  giving  him  a  credit 
on  its  books  technically  known  as  a  ''deposit,"  or  by 
issuing  to  hun  its  own  note  or  the  equivalent  thereof. 
There  is  no  reason  why  the  bank  which  is  thus  applied  to, 
if  it  desires  to  grant  the  credit  at  all,  should  not  give  the 
accommodation  in  either  form  that  may  be  desired  by  the 
customer. 

The  customer  is  likely  to  be  governed  entirely  by  the 
demand  of  the  people  with  whom  he  is  dealing,  as  to  the 
form  of  payment  required.  In  the  case  of  the  bill  of 
goods  for  $100,000  already  spoken  of,  it  is  probable  that 


100  American  Banking 

a  check  on  the  bank  mil  be  exactly  what  he  wants,  in 
which  case  no  question  of  note  issue  is  raised.  But  it 
may  also  be  that  the  funds  are  not  wanted  for  a  single 
payment  of  this  kind,  but  that  accommodation  is  sought 
for  some  purpose  which  necessitates  a  number  of  small 
payments  to  persons  who  do  not  or  can  not  employ  bank 
checks.  In  this  instance,  notes  will  be  needed.  Or  it  may 
happen  that  a  bank  discounts  some  paper  for  the  purpose 
of  getting  notes  with  which. to  supply  actual  calls  for  cur- 
rency made  by  its  customers  who  are  not  necessarily 
borrowers,  but  who  want  notes  to  carry  in  their  pockets 
for  the  purpose  of  meeting  demands  from  day  to  day. 

What  the  Federal  Reserve  Act  does  is  to  permit  a 
bank  to  take  the  promises  of  individuals  to  pay  at  the  end 
of  a  designated  period,  indorse  these  promises  with  its 
o^^^l  signature,  and,  by  the  deposit  of  them  with  the  fed- 
eral reserve  bank,  obtain  in  exchange  federal  reserve 
notes  issued  to  that  bank  by  a  government  officer  known 
as  a  federal  reserve  agent.  The  fact  that  these  notes  are 
technically  obligations  of  the  government  confuses  the 
situation  to  some  extent,  because  it  makes  the  transaction 
appear  as  if  it  were  one  which  involved  the  government 
in  some  way.  As  a  matter  of  fact,  it  is  the  member  bank's 
demand  which  gives  the  signal  for  the  issue  of  the  notes, 
and  determines  how  many  of  them  shall  come  out ;  while 
it  is  the  demand  of  the  customer  of  the  member  bank 
which  influences  the  action  of  that  bank  in  applying  for 
them.  Ultimately  and  in  broadest  terms,  then,  the  pro- 
vision of  the  Federal  Reserve  Act  simply  allows 
individuals  to  make  their  own  obligations,  based  on  com- 
mercial, industrial,  or  agricultural  transactions,  and 
then,  by  putting  these  through  a  local  bank,  to  get  note 
currency  corresponding  thereto.  As  long  as  their  credit 
is  good  they  can  get  the  notes,  provided  the  federal 


Bank  Notes  101 

reserve  bank  is  in  a  position  to  protect  the  notes  amply 
with  gold. 

Under  the  terms  of  the  Federal  Reserve  Act,  this  pro- 
tection must  amomit  to  at  least  40  per  cent  of  the  face 
of  the  note  issue;  and  of  this  40  per  cent,  5  per  cent  is 
deposited  with  the  Treasury  Department  for  current  re- 
demption, the  other  35  per  cent  being  held  in  the  vaults 
of  the  federal  reserve  bank  which  issues  the  notes.  The 
currency  is  thus  elastic,  inasmuch  as  it  can  be  increased 
to  the  extent  of  two  and  one-half  times  the  supply  of  gold 
available — 100  per  cent  being  two  and  one-half  times 
40  per  cent — while  it  is  safe,  inasmuch  as  the  protection 
is  adequate  to  all  ordinary  requirements.  Nothing  limits 
the  amount  of  notes  that  can  be  issued,  therefore,  except 
the  needs  of  the  business  community,  and  the  adjustment 
of  the  country's  gold  supply  to  that  of  other  nations. 

Federal  Reseeve  Bank  Notes 

The  federal  reserve  bank  note  differs  from  the  federal 
reserve  note  in  that  it  is  based  upon  government  bonds 
which  are  deposited  with  the  Treasury  Department  to 
safeguard  it,  just  as  is  the  case  with  national  bank  notes. 
The  federal  reserve  bank,  under  the  provisions  of  the 
Federal  Reserve  Act,  is  permitted  to  buy  government 
bonds  as  a  form  of  investment  if  it  chooses  to  do  so.  In 
addition  to  this,  government  bonds  may  be  assigned  by 
the  Federal  Reserve  Board  to  the  federal  reserve  banks 
in  the  aggregate  to  an  amount  not  to  exceed  $25,000,000 
per  annum,  which  the  latter  may  be  required  to  purchase 
and  pay  for  at  par.  Such  assignment  takes  place  only 
in  the  event  that  member  banks  desiring  to  sell  their 
bonds  file  application  with  the  Treasury  Department  for 
the  disposal  of  their  bonds  and  the  retirement  of  circu- 
lation based  thereon.    If  the  aggregate  of  such  applica- 


102  American  Banking 

tions  is  more  than  $25,000,000  per  annum,  the  Federal' 
Reserve  Board  apportions  the  purchases  among  the 
banks  by  a  method  prescribed  in  the  law,  which  amounts 
to  a  distribution  according  to  capital  and  surplus. 

Inasmuch  as  the  banks  which  thus  seek  to  retire  these 
bonds  are,  of  course,  unable  to  get  back  the  notes  that 
were  issued  on  these  bonds  (the  latter  being  in  circulation 
throughout  the  country),  this  provision  of  the  law 
amounts  to  permitting  the  member  banks  to  transfer  to 
the  federal  reserve  banks,  up  to  the  amount  of  $25,000,- 
000  a  year,  such  government  bonds  as  they  may  have  in 
their  possession,  the  federal  reserve  banks  assuming 
thereby  the  obligation  for  all  outstanding  national  bank 
notes  previously  issued  against  them.  Of  course  the 
transaction  would  not  occur  in  precisely  this  way,  as  the 
federal  reserve  bank  would  pay  for  the  bonds,  and  tlie 
money  would  go  into  the  Treasury,  there  to  be  held 
against  the  outstanding  bank  notes  which  had  been  issued 
on  the  strength  of  these  bonds.  The  federal  reserve  bank 
would  then  be  able  to  issue  its  own  notes  against  the 
bonds  so  taken  over,  if  it  saw  fit,  as  it  doubtless  would; 
but  the  result  would  be  the  same — the  transfer  of  the 
ownership  of  the  bonds  to  the  federal  reserve  bank,  and 
the  assumption  by  the  federal  reserve  bank  of  the  liability 
for  the  notes. 

It  is  easy  to  see  that  if  this  process  went  on  for  about 
thirty  years  at  the  rate  of  $25,000,000  per  annum,  all  the 
national  bonds  would  have  been  taken  over  by  the  federal 
reserve  banks,  the  national  bank  notes  based  thereon 
retired,  and  an  equal  amount  of  federal  reserve  bank 
notes  issued  in  their  place.  We  should  then  have  this 
underljdng  sub-structure  of  federal  reserve  bank  notes 
(or,  in  the  interim,  of  federal  reserve  bank  notes  and 
national  bank  notes  combined) ;  while  above  would  be  the 


Bank  Notes  103 

super-structure  of  federal  reserve  notes  based  on  redis- 
counted  commercial  paper,  and  varying  in  amount 
according  to  the  needs  of  the  country. 

How  great  are  such  needs  ?  They  are,  of  course,  only 
temporary  and  exceptional  needs,  for  the  regular,  steady, 
permanent  demands  are  met  by  the  underlying  structure 
of  bond-secured  notes.  These  varying  demands  are  in 
part  the  result  of  so-called  "seasonal"  calls  for  the  mov- 
ing of  crops  and  the  like,  and  in  part  the  result  (at 
special  times)  of  so-called  "panic"  demands.  There  is 
no  positive  information  as  to  the  actual  amount  of  the 
seasonal  demands  for  crop  moving.  They  vary  greatly ; 
and  as  long  as  there  is  in  existence  a  large  underlying 
body  of  notes,  there  will  always  be  more  or  less  shipment 
of  currency  from  one  part  of  the  country  to  another  to 
meet  seasonal  calls. 

The  extent  of  the  panic  demands  can  be  estimated  on 
the  basis  of  the  experience  during  the  autumn  of  1914. 
At  that  time  calls  were  made  on  the  Treasury  Depart- 
ment under  the  section  of  the  Reserve  Act,  which  extends 
the  operation  of  the  so-called  Aldrich-Vreeland  Law 
through  local  "currency  associations"  for  sums  aggre- 
gating about  $380,000,000.  This  was  the  result  of  an 
extremely  severe  currency  demand  and  under  no  ordi- 
nary conditions  would  again  be  witnessed.  If  we  estimate 
the  ordinary  normal  seasonal  demands  at  one-third  of 
this  amount,  it  would  probably  be  an  amply  high  figure. 
The  war,  however,  has  upset  old  standards.  The  great 
influx  of  gold  made  possible  a  larger  credit  and  currency 
expansion  than  was  even  thought  of  in  1914.  The  amend- 
ment of  June  21,  1917,  centralizes  legal  reserves  of 
member  banks  in  the  federal  reserve  system  and  permits 
gold  and  gold  certificates  held  by  a  federal  reserve  bank 
as  collateral  to  be  counted  as  part  of  the  gold  reserve 


104  American  Banking 

dollar  for  dollar.  There  can  be  no  doubt  that  the  quan- 
tity of  legitimate  commercial  paper  in  current  existence 
is  ample  to  sustain  even  the  maximum  demand  for  cur- 
rency thus  indicated,  so  that  it  may  truly  be  said  that  the 
federal  reserve  system  is  fully  able  to  supply  an  elastic 
currency  issued  to  any  reasonable  amount  that  may  be 
called  for.  The  only  limitation  upon  the  currency  is 
the  demand  of  the  community,  and  the  existence  of  actual 
live  transactions  calling  for  it. 

Note  Elasticity 

It  is  precisely  the  quality  of  elasticity  that  is  most 
important  from  the  currency  standpoint;  and  it  is  pre- 
cisely the  absence  of  this  quality  that  has  made  it  evident 
that  the  national  bank-note  circulation  was  unsatisfac- 
tory. A  truly  elastic  circulation  is  one  which  will  come 
into  existence  whenever  there  is  a  sudden  demand  for 
additional  circulating  medium,  and  will  as  promptly  go 
out  of  existence  when  such  demand  has  passed.  Thus, 
if  there  is  a  season  of  the  year  at  which  an  increase  in 
circulating  medium  is  needed  in  excess  of  what  is  wanted 
at  other  seasons,  an  elastic  currency  renders  it  possible 
to  get  this  circulating  medium  without  the  importation 
of  actual  money  from  abroad. 

There  are  such  times  in  the  United  States,  and  par- 
ticularly in  the  autumn,  when  the  so-called  '^  crop-moving 
season"  occurs,  there  is  usually  a  rather  sharp  demand 
for  more  circulating  medium  to  be  used  in  paying  farm- 
ers' bills.  If  the  banks  can  issue  such  circulation  freely 
they  can  supply  the  need.  In  the  same  way,  when  the 
demand  for  the  increased  circulation  has  passed  by,  the 
notes  will  come  back  to  the  banks,  be  redeemed,  and  go 
out  of  circulation.  Such  is  the  case  in  Canada.  But 
in  the  United  States  the  issue  of  bank  notes  under  the 


Bank  Notes  105 

old  bond-security  system  has  been  very  sluggish  and  their 
retirement  slow.  The  small  profit  earned  by  the  banker 
upon  his  note  issues  has  not  been  sufficient  to  make  him 
very  active  in  retiring  the  notes  of  others  by  presenting 
them  for  redemption,  so  that  a  condition  of  almost  com- 
plete "inelasticity"  has  been  characteristic  of  our 
national  bank  circulation. 

It  should  be  observed  also  that  the  cost  of  getting  out 
our  national  bank  notes,  due  to  the  necessity  of  buying 
bonds  and  obtaining  notes  through  the  Treasury  Depart- 
ment, made  it  necessary  for  the  banker  to  charge  a 
higher  rate  of  interest  on  his  loans  than  if  he  had  been 
able  to  get  the  notes  out  with  less  expensive  precau- 
tions. The  consequence  that  in  those  parts  of  the 
country  where  commercial  conditions  called  for  the  use  of 
notes,  the  cost  of  bank  loans  has  been  abnormally  high 
and  the  amount  that  has  had  to  be  paid  by  the  borrower 
has  raised  his  general  expenses  of  production  in  a  cor- 
responding degree.  If,  as  a  result  of  the  difficulties 
surrounding  the  issue  of  notes,  the  borrower  is  obliged 
to  pay  an  extra  rate  of  interest  at  the  crop-moving  time 
or  on  some  similar  occasion,  the  effect  is  to  hamper  him 
in  a  corresponding  degree.  This  operates  to  lower  his 
profits  for  the  season,  or  else  to  compel  him  to  raise  his 
prices  if  he  can. 

It  is  not  a  benefit  to  the  banker  because  it  necessarily 
restricts  the  amount  of  business  he  would  otherwise  be 
able  to  do,  since  bank  loans,  like  most  other  classes  of 
purchasable  goods  or  services,  attain  a  wider  use  as  their 
cost  becomes  lower.  The  high  cost  and  inelasticity  of 
the  currency  thus  inevitably  raises  cost  of  production. 
Conversely,  in  countries  where  bank  credit  is  rendered 
as  cheap  as  possible  and  the  security  of  the  note-holder 
is  attained  by  careful  inspection  of  bank  loans  and  bank 


106  American  Banking 

securities,  usually  carried  on  by  the  government  for 
the  purpose  of  seeing  that  no  irregular  transactions  have 
been  undertaken,  one  element  in  industrial  cost  is  reduced 
and  the  competitive  position  of  the  persons  who  are 
obliged  to  borrow  at  the  banks,  as  most  business  men 
nowadays  are,  is  correspondingly  improved.  The  elastic 
currency  provisions  of  the  Federal  Reserve  Act  should 
greatly  improve  the  conditions  just  described. 

TEST  QUESTIONS 

1.  Explain :    "The  note  is  a  means  of  extending  credit." 

2.  Why  is  a  bank  note  a  ' '  sight  liability ' '  ? 

3.  How  do  bank  notes  differ  from  checks? 

4.  "What  is  meant  by  the  currency  function  of  bank  notes? 

5.  Explain  five  methods  used  for  protecting  bank  notes. 

6.  How  does  a  bank  determine  whether  or  not  it  can  profit- 
ably issue  notes? 

7.  Explain  some  systems  used  for  securing  the  redemption 
of  bank  notes. 

8.  What  are  the  tests  of  a  good  redemption  plan? 

9.  Explain  the  nature  of  the  federal  reserve  notes.     Upon 
what  security  are  they  based  ? 

10.  How  do  federal  reserve  bank  notes  differ  from  federal 
reserve  notes? 

11.  What  is  meant  by  "note  elasticity"? 

12.  What  devices  are  used  to  secure  this  elasticity  ? 


CHAPTER  IX 
clearing  houses 

Geowth  of  Association  in  Banking 

We  have  assumed  thus  far  that  banking  went  on  pretty 
much  in  a  competitive  way  and  with  little  association  of 
effort  or  unity  of  purpose  on  the  part  of  the  banks  them- 
selves. We  have  assumed  that  the  banks  were  simply 
competitive  in  their  efforts,  searcliing  for  business  at 
one  another's  expense,  or  at  all  events  without  regard  to 
one  another's  welfare,  just  as  is  the  case  with  firms  in 
any  line  of  business.  To  a  large  extent  this  assumption, 
of  course,  holds  true  of  banking  just  as  it  does  of  other 
classes  of  business,  but  there  is  a  large  and  growing 
sense  in  which  the  statement  is  not  true. 

In  banking  more  than  any  other  line  of  business,  prob- 
ably, it  has  come  to  be  recognized  that  the  welfare  of 
one  institution  is  dependent  upon  the  welfare  of  all  in 
a  very  large  degree  and  that,  where  one  or  several  banks 
go  to  destruction  in  a  community,  the  danger  is  that  all 
the  others  will  do  likewise,  or  at  all  events  that  they  will 
be  seriously  crippled  as  a  result  of  the  bad  conditions 
created  by  the  failure  of  the  weak  institutions.  As  a 
result  of  the  recognition  of  this  fact,  there  is  now  a 
distinct  effort  in  all  countries  of  the  world,  on  the  part 
of  bankers  of  intelligence  and  leading,  to  bring  about 
a  generally  sound  state  of  affairs  in  their  profession,  to 
eliminate  all  those  elements  which  make  for  weakness, 
and  in  case  such  elements  develop,  to  endeavor  to  improve 

107 


108  American  Banking 

conditions  gradually  and  systematically  rather  than  to 
allow  the  public  to  become  alarmed.  This  effort  is  not 
only  in  the  interest  of  sounder  and  better  banking  and 
of  higher  professional  standards,  but  it  is  also  in  the 
interest  of  the  public,  which  is  thereby  safeguarded 
and  is  taught  to  look  to  the  banks  of  the  community  as 
a  group  to  protect  it  against  loss  or  danger. 

There  are  several  ways  worthy  of  note,  in  which  this 
effort  to  secure  what  may  be  called  association  or  co-op- 
eration in  banking  is  being  carried  out.  In  one  way,  the 
effort  is  seen  through  the  organization  of  clearing  houses 
which  not  only  work  towards  the  ends  indicated  but  also 
are  labor-saving  institutions,  as  will  presently  be  indi- 
cated. The  same  tendency  is  seen  in  the  organization  of 
bankers'  associations  ha\dng  educational  and  protective 
functions  and  working  for  legislation  presumably  of  a 
more  appropriate  type  than  that  on  the  statute  books. 
There  are  other  lines  along  which  the  same  effort  is  being- 
prosecuted.  But  of  all  these  methods  the  one  which  has 
attained  the  most  significance  is  the  clearing  house. 

Natuee  of  Cleaeustg  Houses 

In  the  United  States  today  there  are  163  regularly 
organized  clearing  houses.  These  have  sprung  up  prac- 
tically since  1854  when  the  New  York  clearing  house  was 
organized.  Today  important  clearing  houses  are  found 
in  New  York,  Boston,  Philadelphia,  Chicago,  St.  Louis, 
San  Francisco,  Pittsburgh,  and  many  other  important 
cities.  They  are  also  found  in  smaller  towns  where  condi- 
tions have  been  such  as  to  demonstrate  the  need  for  them. 
In  Europe,  the  lead  of  the  United  States  has  been  fol- 
lowed by  the  establishment  of  the  French  ''Chambres  de 
Compensation,"  and  the  German  *' Clearing  Houses"  this 
word  having  been  borrowed  from  our  own  nomenclature. 


Clearing  Houses  109 

This  rapid  spread  of  the  use  of  the  clearing  house  has 
been  due  to  a  recognition  of  its  importance  and  a  desire 
by  means  of  it  to  attain  the  important  economies  which 
experience  has  shown  can  be  derived  from  it  along  a 
number  of  different  lines.  The  clearing  house  has  proved 
not  only  an  economizer  of  cash  and  labor  but  also  a  most 
important  agency,  as  already  pointed  out,  in  promoting 
co-operation  in  banking  and  an  effective  means  for 
relieving  panic  and  lack  of  confidence. 

The  clearing  house  itself  is  nothing  more  than  an 
unincorporated  association  of  banks  and  bankers.  It 
has  a  constitution  and  by-laws  of  its  own  designed  to 
control  membership  and  the  type  of  operation  in  which 
the  clearing  house  shall  engage,  as  well  as  to  apportion 
the  expense  among  the  various  members.  In  some  places 
the  local  clearing  house  has  an  elaborate  building  and 
equipment  of  its  own,  while  in  others  its  work  is  carried 
on  in  simpler  quarters  rented  for  the  purpose.  But  no 
matter  how  complex  or  wealthy  a  clearing  house  may  be, 
the  essential  idea  of  the  clearing  process  is  the  same. 

The  Clearing  Process 

The  clearing  process  can  be  best  understood  by  think- 
ing of  it  as  in  one  sense  a  bank  for  banks.  From  this 
point  of  view,  the  different  banks  which  are  members  of 
the  clearing  house  sustain  to  one  another  very  much  the 
same  relationship  that  individuals  sustain  to  a  bank  at 
which  they  all  deposit.  How  this  is  can  be  understood 
from  a  simple  illustration.  Suppose  that  ten  persons, 
A,  B,  C,  D,  etc.,  are  all  in  the  habit  of  doing  business 
with  a  given  bank.  Let  us  suppose  that  they  all  get 
their  loans  from  this  banlv,  make  their  deposits  with  the 
bank,  and  do  business  with  one  another  and  with  no 
other  person.    Then  the  individuals  will  deposit  with  the 


110  American  Banking 

bank  only  money  and  currency  and  checks  drawn  upon  it 
by  others.  All  that  the  bank  will  have  to  do  in  order  to 
pay  the  checks  will  be  to  make  certain  records  in  its 
books.  That  is  to  say,  if  A  comes  in  with  a  batch  of 
checks  drawn  in  his  favor  by  B,  C,  D,  etc.,  while  B  comes 
in  with  a  batch  drawn  in  his  favor  by  C,  D,  E,  etc.,  the 
checks  will  be  paid  by  making  transfers  on  the  books 
of  the  bank  from  the  accounts  of  B,  C,  D,  etc.,  in  favor 
of  A,  and  from  the  accounts  of  C,  D,  E,  etc.,  in  favor  of 
B,  and  so  on  through  the  list. 

Now,  it  would  be  entirely  possible  that  in  the  course  of 
a  month,  say,  each  of  these  depositors  should  have  drawn 
exactly  the  same  amount  in  favor  of  the  others.  If  that 
were  true  every  man  would  have  paid  what  he  owed  to 
the  others  and  would  have  received  what  was  owed  him 
by  the  others  without  a  single  cent 's  having  been  used  in 
liquidation.  This  would  be  an  example  of  a  perfect 
clearing  transaction,  the  clearing  process  being  the  off- 
setting of  checks  and  credit  devices  against  one  another 
in  such  a  way  as  to  obviate  the  use  of  cash  as  far  as 
possible. 

Exactly  the  same  thing  is  done  by  a  clearing  house  for 
the  banks  which  compose  it.  All  individuals  do  not  do 
their  business  with  the  same  bank,  nor  do  they  do  busi- 
ness exclusively  with  one  another  in  trade  and  commerce. 
Consequently  every  bank  receives  a  large  number  of 
checks  and  drafts  which  it  wants  to  collect  of  other  banks. 
It  might  send  a  bank  messenger  with  a  bundle  of  checks 
and  drafts  to  each  of  the  banks  on  which  it  had  a  claim 
and  let  this  messenger  bring  back  the  coin  or  currency  in 
a  bag.  Then  the  other  banks  might  send  to  it  in  the  same 
way.  The  result  would  be  that  while  a  messenger  ^vith 
$50,000  was  coming  to  the  bank,  another  messenger  with 
$50,000  might  be  lea^dng  the  bank.    Money  would  thus 


Clearing  Houses  111 

be  in  transit  all  the  time  and  the  risk  of  robbery  would 
be  much  greater. 

Suppose  that,  instead  of  doing  the  business  in  this 
simple  and  elementary  way,  each  of  the  banks  sends  a 
messenger  at  a  certain  hour  every  day  to  a  designated 
spot,  the  messenger  taking  with  him  all  the  checks  and 
drafts  held  by  the  bank  against  other  banks.  Upon  reach- 
ing the  spot  in  question,  the  messengers  trade  packages. 
Then  the  place  becomes  a  clearing  house  and  the  process 
of  swapping  the  checks  and  drafts  is  the  clearing  process. 
While  it  is  true  theoretically,  that  this  process  might 
work  out  evenly,  so  that  every  bank  would  exchange 
exactly  the  same  amount  of  checks  and  drafts  that  were 
offered  against  it,  this  is  seldom  or  never  the  case  for 
obvious  reasons.  One  bank  may  be  gaining  in  business 
at  the  expense  of  the  others  or  it  may  be  temporarily 
financing  some  large  transactions.  There  is  thus  usually 
a  small  balance  to  be  paid — sometimes  larger  and  some- 
times smaller  but  in  the  aggregate  small,  when  measured 
as  a  percentage  of  the  total  transactions  that  are  carried 
out  in  the  clearing  house. 

Clearing-Hotjse  Cash 

It  is  plain  that  while  the  amount  of  cash  actually  trans- 
ferred may  be  very  small  as  a  percentage  of  the  gross 
amount  of  transactions,  it  may  be  very  large  in  the  aggre- 
gate, as  a  sum  of  money.  Thus,  if  a  clearing  house  does 
a  business  of  $1,000,000,000  annually  and  if  5  per  cent 
of  all  the  payments  have  to  be  made  in  cash,  this  would 
mean  the  transfer  of  $50,000,000  in  cash  each  year.  If 
the  clearing  house  has  suitable  vaults  so  that  every  bank 
can  keep  a  certain  amount  of  its  coin  on  deposit  there, 
it  can  transfer  the  title  to  this  coin  to  other  banks  by 
giving  them  paper  titles  thereto,  these  titles  being  then 


112  American  Banking 

analogous  to  the  ordinary  check  drawn  by  the  individual 
on  a  bank.  Such  paper  titles  are  called  "clearing-house 
certificates."  Where  these  are  used,  if  a  bank  presents 
say  $100,000  in  checks  and  drafts  against  other  banks  and 
has  $105,000  presented  against  it,  it  has  liquidated  in 
the  exchange  process  all  except  $5,000.  Now  it  can 
liquidate  that  by  handing  out  clearing-house  certificates 
to  that  amount  and  thereby  decreasing  its  balance  with 
the  clearing  house  in  a  similar  degree.  Of  course  the 
same  result  would  be  attained  if  the  clearing  house  kept 
its  funds  on  deposit  with  some  one  bank  and  the  transfer 
were  made  by  giving  checks  on  that  bank. 

Now  if,  in  the  course  of  a  year,  a  bank  maintains  about 
a  stable  volume  of  business  so  that  it  receives  practically 
as  much  as  it  pays  out,  it  is  entirely  conceivable  that  it 
will  get  the  same  amount  in  clearing-house  certificates 
that  it  pays.  It  may  run  behind  steadily  during  January, 
February,  and  March  and  gain  steadily  during  April, 
May,  and  June,  and  so  on.  At  the  end  of  the  year  it  may 
find  itself  in  just  the  same  position  with  reference  to  the 
clearing  house  that  it  was  in  the  beginning.  In  such  a 
case,  all  its  transactions  have  been  liquidated  without  the 
use  of  cash  and  on  a  pure  credit  basis.  This  makes  the 
value  of  the  clearing-house  system  sufficiently  obvious. 

SlGlSTmCANCE    OF    ClEAEINGS 

From  what  has  been  said,  it  is  plain  that  the  clearing 
house,  however  great  its  labor-saving  and  cost-saving 
significance,  is  not  an  institution  from  which  banks  derive 
a  direct  profit.  They  would  never  carry  on  a  clearing 
function  simply  for  the  fun  of  the  thing  but  only  as  a 
result  of  business  transactions.  That  means  that  the 
statements  showing  the  amount  of  clearing-house  trans- 
actions have  an  important  business  significance.  When 
they  are  large  they  indicate  that  a  great  deal  of  business 


Clearing  Houses  113 

is  being  done  at  the  banks,  and  this  of  course  means  that 
a  great  many  people  are  borrowing.  The  following  table 
shows  the  transactions  of  the  clearing  house  of  the  United 
States  over  a  period  of  two  years. 

Comparative  Statement,  in  Millions  of  Dollars,  of  Clearings  of  the 
United  States  for  the  Years  Ended  Sept.  30,  1913  and  1914 

Exchanges  for  Exchanges  for 

year  ending  year  ending 

Sept.  30,  1913  Sept.  30,  1914 

New    York $98,121.5  $89,760.3 

Chicago   16,018.2  16,139.9 

Boston   8,326.2  7,866.7 

Philadelphia   8,543.5  8,231.5 

St.  Louis 4,122.1  4,050.8 

Pittsburgh    2,951.9  2,725.4 

Kansas  City 2,835.2  2,831.8 

San  Francisco    2,666.6  2,544.2 

Baltimore    2,010.4  1,899.4 

Cincinnati   1,329.7  1,331.6 

Minneapolis    1,326.1  1,318.3 

Detroit     1,286.9  1,385.6 

Qeveland    1,271.2  1,271.1 

Los  Angeles  1,234.1  1,182.8 

New  Orleans    1,002.1  974.4 

Total    $1.53,046.7  $143,513.8 

Total,  148  other  cities         20,146.3  20,461.9 

Grand  total   $173,193.0  $163,975.7 

The  New  York  Clearing  House  as  seen  from  the  fore- 
going showing  is  the  most  important  clearing  house  in 
the  country,  and  has  larger  transactions  than  others  and 
gets  along  with  probably  a  smaller  amount  of  cash  pay- 
ments in  the  long  run  than  any  other  considerable  clear- 
ing house.  There  is  another  reason,  however,  why  the 
New  York  Clearing  House  is  of  more  interest  and  sig- 
nificance than  the  clearing  houses  of  most  places  and  why 


114  American  Banking 

its  figures  are  better  worthy  of  study.  This  reason  de- 
mands a  brief  explanation. 

' ' OuT-OF-Towisr  Checks" 

We  have  been  speaking  as  if  the  bank  clearing  houses 
in  any  given  place  did  business  only  for  and  with  banks 
in  that  place.  This  is,  to  an  extent,  true  of  a  considerable 
number  of  clearing  houses  but  it  is  not  true  of  the  more 
important  ones.  In  a  former  chapter  some  description 
has  been  given  of  the  system  whereby  national  bank 
reserves  under  the  National  Bank  Act  as  it  existed  prior 
to  the  Federal  Reserve  Act  are  redeposited  with  banks 
in  reserve  cities.  There  is  more  reason  for  this  system 
of  redepositing  than  is  to  be  found  simply  in  the  desire 
of  the  banks  to  earn  interest  on  the  redeposits  they  thus 
make. 

Every  bank  is  called  upon  to  furnish  a  means  of  pay- 
ment at  a  distance,  and  it  does  so  by  the  use  of  drafts, 
which  are  practically  checks  upon  another  bank  whose 
funds  are  more  available  to  the  customer  or  the  man 
who  is  to  be  paid.  Thus,  a  man  in  New  Orleans  who  has 
bought  goods  from  a  New  York  jobber  may  go  to  his 
bank  in  which  he  has  a  deposit  and  ask  that  bank  for  a 
draft  on  New  York.  The  bank  practically  draws  a  check 
upon  the  funds  which  it  has  on  deposit  with  its  corres- 
pondent in  New  York.  The  New  Orleans  merchant  takes 
this  draft  and  mails  it  to  his  creditor  in  New  York,  who 
then  deposits  it  in  his  own  bank. 

The  New  York  man  may,  however,  be  willing  to  accept 
a  check  on  a  New  Orleans  bank,  in  which  case  the  New 
Orleans  man,  instead  of  securing  a  draft  on  New  York, 
may  simply  send  his  own  check  on  his  New  Orleans  bank 
to  his  creditor  in  New  York,  who  promptly  deposits  it 
in  his  own  bank. 


Clearing  Houses  115 

In  this  latter  case,  how  is  the  bank  which  has  received 
this  New  Orleans  check  on  deposit  to  secure  payment 
for  it? 

It  does  so  through  the  clearing  house.  That  is  to  say, 
it  presents  the  check  to  the  bank  in  New  York  w^hicli  acts 
as  correspondent  for  the  New  Orleans  bank  on  which  the 
check  is  drawn,  and  the  bank  pays  it  and  charges  it  to 
the  account  of  the  New  Orleans  bank.  If  the  draft  is 
drawn  directly  on  the  New  York  bank  by  the  New^  Orleans 
bank,  the  transaction  is  simpler.  The  correspondent 
bank  in  New  York  simply  receives  the  draft  on  it  and 
deducts  the  amount  from  the  credit  of  the  New  Orleans 
institution. 

Suppose,  however,  that  the  New  York  bank  which 
received  the  check  or  draft  on  deposit  were  not  a  member 
of  the  New  York  Clearing  House,  how  would  it  manage? 
It  might  send  the  draft  in  the  old  primitive  way  directly 
to  the  New  York  bank  on  which  it  was  drawn  and  collect 
it  in  cash,  but  this  is  not  the  way  that  would  be  followed 
in  practice.  In  practice,  the  check  would  be  deposited 
with  some  bank  which  was  a  member  of  the  clearing 
house,  to  the  credit  of  the  bank  w^hich  received  it.  Then 
this  bank  would  go  through  the  process  of  collecting  it. 
It  might  easily  be  that  neither  the  bank  on  which  the 
check  was  drawn  nor  the  bank  with  w^hich  it  was  deposited 
was  a  member  of  the  clearing  house.  In  that  case,  the 
check  would  be  deposited  with  a  clearing-house  bank,  as 
already  indicated,  and  collected  from  another  clearing- 
house bank  which  was  acting  as  the  agent  of  the  non-clear- 
ing-house bank  on  which  the  check  or  draft  was  drawn. 
Thus,  the  out-of-town  check  or  draft,  as  well  as  the  checks 
or  drafts  drawn  on  local  non-member  banks,  would  be 
cleared  in  exactly  the  same  way  and  with  no  more  delay 


116  American  Banking 

than  if  it  had  been  directly  drawn  on  and  deposited  with 
a  clearing-house  bank. 

The  clearing  house  thus  serves  an  important  function 
in  clearing  the  funds  which  flow  to  the  place  where  the 
clearing  house  is  situated.  As  New  York  is  to  a  large 
extent  the  financial  center  of  the  country,  its  clearings 
are  of  greater  interest  and  importance  than  those  of  any 
other  city,  and  throw  more  light  upon  the  drift  of  busi- 
ness and  the  development  of  commerce  than  do  those  of 
any  other  place.  Allowance  should  always  be  made  for 
tlie  effect  of  stock-market  transactions  upon  the  volume 
of  clearings  in  the  city  of  New  York.  When  trade  upon 
the  Exchange  is  active,  clearings  are  larger  in  propor- 
tion and  vice  versa. 

Pkovision  for  National  Clearance  System 

When  the  Federal  Reserve  Act  provided  for  trans- 
ferring the  reserves  of  member  banks  to  federal  reserve 
banks,  and  limited  the  counting  of  bank  balances  with 
other  banks  as  reserves,  the  question  inevitably  pre- 
sented itself  to  the  f ramers  of  the  law  how  to  provide  for 
the  collection  of  checks  in  the  best  manner.  An  analysis 
of  the  whole  situation  convinced  those  who  were  engaged 
upon  the  Federal  Reserve  Act  that  if  the  reserves  were 
transferred,  the  task  of  collection  should  likewise  be 
transferred — that  is  to  say,  if  a  federal  reserve  bank  was 
to  be  the  holder  of  the  reserves  of  its  member  banks,  it 
should  also  be  called  upon  to  take  care  of  their  collec- 
tions. A  consideration  which  strongly  supported  this 
view  was  the  fact  that  by  placing  the  task  of  collection 
upon  the  federal  reserve  banks,  it  would  be  possible  to 
eliminate  a  very  large  part  of  the  expense  included  under 
the  existing  collection  system. 

As  has  already  been  briefly  shown  at  an  earlier  point, 


Clearing  Houses  117 

the  present  collection  sj^stem  is  costly  because  of  the 
funds  that  must  be  carried,  and  because  of  the  high 
clerical  expense  involved  in  routing  and  transmitting 
checks,  and  in  getting  back  the  proceeds  resulting  from 
their  collections.  If  the  federal  reserve  bank  of  a  district 
included  all  the  banks  of  that  district,  each  keeping  a 
balance  with  the  reserve  bank,  and  if  the  reserve  bank 
undertook  to  receive  from  its  members  all  checks  upon 
other  members,  the  process  of  collection  would  be  effected 
by  merely  charging  off  or  crediting,  as  the  case  might 
be,  upon  the  books  of  the  federal  reserve  bank,  the  incom- 
ing checks  being  distributed  at  the  end  of  the  day,  week, 
or  month  to  the  member  banks,  just  as  any  ordinary 
bank  returns  the  checks  drawn  by  its  depositors  when- 
ever such  depositors  present  their  bank  books  for 
balancing.  Furthermore,  since  the  federal  reserve  bank^ 
under  the  terms  of  the  supposition,  would  be  carrying  a 
balance  with  every  bank  in  the  district,  the  fund  already 
referred  to  would  largely  disappear. 

Of  course,  so  far  as  a  federal  reserve  bank  did  not 
include  in  its  membership  all  the  banks  of  the  district,  the 
system  would  be  imperfect,  but  it  would  render  very 
much  the  same  service,  so  far  as  it  went,  as  if  it  included 
them  all.  By  making  business  arrangements  with  clear- 
ing houses  in  those  places  where  there  are  many  state 
banks,  the  federal  reserve  banks  would  be  able  to  per- 
form much  of  the  work  that  would  have  fallen  to  them 
under  a  condition  where  all  banks  of  the  district  were 
included  in  their  membership. 

Shortly  after  the  Federal  Reserve  Board  was  organ- 
ized, it  received  applications  from  two  districts — those 
of  Kansas  City  and  St.  Louis — for  permission  to  under- 
take the  general  clearing  of  checks  drawn  upon  their 
member  banks.    This  was  granted,  and  the  two  banks  in 


118  American  Banking 

question  promptly  undertook  to  receive  on  deposit  at 
par,  without  charge  for  collection,  any  checks  originally 
drawn  on  the  banks  in  their  respective  districts.  The 
plan  was  highly  successful  from  the  start. 

The  amendment  of  June  21,  1917,  contains  these  pro- 
visions for  collections  and  clearings : 

Any  federal  reserve  bank  may  receive  from  any  of  its  mem- 
ber banks,  and  from  the  United  States,  deposits  of  current  funds 
in  lawful  money,  national  bank  notes,  federal  reserve  notes,  or 
cheeks  and  drafts  payable  upon  presentation,  and  also,  for  col- 
lection, maturing  notes  and  bills;  or,  solely  for  purposes  of  ex- 
change or  of  collection,  may  receive  from  other  federal  reserve 
banks  deposits  of  current  funds  *  *  *;  or,  solely  for  pur- 
poses of  exchange  or  of  collection  may  receive  from  any  non- 
member  bank  or  trust  company  deposits  of  current  funds 
*  *  * ;  provided,  such  nonmember  bank  or  trust  company 
maintains  with  the  federal  reserve  bank  of  its  district  a  balance 
sufficient  to  offset  the  items  in  transit  *  *  * ;  provided 
further,  that  nothing  in  this  Act  shall  be  construed  as  prohib- 
iting a  member  or  nonmember  bank  from  making  reasonable 
charges  to  be  determined  and  regulated  by  the  federal  reserve 
board,  but  in  no  case  to  exceed  10  cents  per  $100  or  fraction 
thereof,  based  on  the  total  of  checks  and  drafts  presented  at 
any  one  time  j  *  *  *  but  no  such  charges  shall  be  made 
against  the  federal  reserve  banks. 

Gold  Settlement  at  Washington 

It  was  seen  by  the  Federal  Reserve  Board  that  the 
intra-district  plan  would  probably  not  work  well  unless 
some  system  were  devised  for  the  clearance  and  collec- 
tion of  checks  between  districts;  and  consequently  the 
Board  had,  at  an  early  date,  taken  up  the  question  of 
establishing  a  central  clearing  fund  in  the  hands  of  the 
Board  itself.  Plans  for  sflch  a  fund  had  been  framed  by 
a  special  committee  of  investigators  named  by  the  organ- 


Clearing  Houses  119 

ization  committee  appointed  under  the  Federal  Reserve 
Act;  and  the  plan  which  had  been  devised  by  this  com- 
mittee, as  set  forth  in  their  report,  was  subsequently 
taken  as  the  essential  basis  of  the  Board's  plan  of  clear- 
ance. A  committee  representing  the  governors  of  reserve 
banks  co-operated  in  arranging  details  of  the  plan,  but 
no  important  change  was  introduced  into  the  general 
idea. 

The  fundamental  conception  was  that  of  a  deposit  of 
gold  to  be  made  by  each  federal  reserv^e  bank  with  the 
Federal  Reserve  Board,  the  actual  gold  being  held  in 
sub-treasuries  for  safe-keeping,  while  the  Board  itself 
merely  held  possession  of  certificates  representing  the 
title  to  the  gold.  Each  federal  reserve  bank  continued 
to  carry  its  gold  in  the  Gold  Settlement  Fund  as  a  part 
of  its  reserves,  representing  it  in  this  way  on  its  books. 
Then  from  week  to  week  the  amount  of  the  items  due  to 
other  federal  reserve  banks  was  to  be  telegraphed  to 
Washington,  and  there  offset  on  the  books  of  the  Gold 
Settlement  Clearing  Fund.  The  result  would  be  to  bring 
about  a  general  cancellation  of  the  bulk  of  the  claims 
between  federal  reserve  banks. 

From  one  point  of  view,  there  was  thus  created  a  gen- 
eral national  clearance  system,  although  this  was  limited 
in  its  scope  by  the  extent  of  the  clearing  carried  on  in 
the  several  districts  under  the  intra-district  clearance 
plan.  It  will  be  observed  that  there  was  still  lacking 
any  system  for  inter-district  clearance — that  is  to  say, 
no  plan  had  been  devised  for  the  depositing  of  checks 
with  a  member  bank,  if  they  had  been  drawn  upon  mem- 
ber banks  in  other  districts.  The  lack  of  such  a  provision 
prevented  checks  thus  drawn  from  going  through  the 
federal  reserve  bank  in  the  district  in  which  the  recipient 
of  such  checks  was  situated.    That  is  to  say,  there  is  as 


120  American  JJaiiking 

yet  under  the  federal  reserve  system  no  plan  whereby  a 
man  living  in  New  York  who  receives  a  check  on  a  San 
Francisco  bank  can  deposit  this  check  with  his  own  bank 
in  the  expectation  that  the  latter  will  collect  it  through 
its  own  federal  reserve  bank. 

The  ultimate  success  of  this  new  clearance  system, 
both  intra-district  and  national,  must  of  course  be  some- 
what dependent  upon  the  extent  to  which  banks  come  into 
the  system.  This  is  not  merely  because  of  the  desirabil- 
ity of  having  the  transactions  constitute  a  large  propor- 
tion of  the  total,  but  because  the  success  and  economy  of 
the  plan  largely  depend  upon  its  being  complete.  In 
order  to  have  the  checks  and  drafts  offset  one  another, 
both  sides  of  the  debtor  and  creditor  equation  must  be 
represented.  A,  for  example,  who  draws  checks  on  his 
bank  to  the  extent  of  $500  per  month  for  the  payment 
of  expenses,  must  receive  $500  per  month  from  some 
other  source  in  order  to  restore  his  account;  otherwise 
his  bank  balance  will  shortly  be  exhausted.  Taking  the 
country  as  a  whole,  checks  and  drafts  do  thus  offset  one 
another  to  a  large  extent,  and  if  a  plan  of  general  bal- 
ancing can  be  developed,  the  result  will  be  to  eliminate 
a  large  proportion  of  the  cost  of  collection.  As  the  num- 
ber of  banlis  which  are  members  of  the  federal  reserve 
clearing  system  increases,  the  advantage  and  economy 
to  those  already  included  in  the  system  will  correspond- 
ingly increase. 

Strengthening  CoNFmENCE 

In  normal  times,"  the  operations  of  the  clearing  houses 
of  the  country  go  on  as  has  been  explained,  steadily  and 
silently  without  any  display  and  without  the  knowledge 
of  the  general  run  of  the  community.  Very  little  cash 
is  used  and  the  whole  mechanism  is  primarily  a  labor- 


Clearing  Houses  121 

saving  and  cost-saving  device.  But  times  may  come 
when  banks  get  into  a  precarious  condition  and  their 
reserves  run  low.  The  public  may  hear  rumors  of  the 
situation,  and,  alarmed  for  the  safety  of  their  funds, 
they  may  begin  to  stop  depositing  in  a  given  bank  or 
banks,  checking  out  what  they  have  there  or  possibly 
even  drawing  it  out  by  actually  going  to  the  bank  and 
demanding  currency. 

The  latter  operation  is  the  familiar  "run"  on  the  bank, 
but  the  silent  steady  drain  which  comes  from  failure  to 
deposit  and  the  checking  out  of  whatever  credits  men 
may  have,  such  checks  being  deposited  elsewhere,  is  far 
more  likely  to  be  fatal  to  the  institution.  Where  this 
occurs  and  a  bank  or  group  of  banks  is  on  the  down- 
ward grade  in  the  estimation  of  the  community,  the 
situation  finally  conies  to  a  point  where  the  bank  or  banks 
that  have  fallen  into  discredit  have  a  great  many 
more  checks  presented  against  them  at  the  clearing  house 
than  they  receive  against  others.  They  are  able  to  endure 
this  for  a  time,  but  in  the  long  run  their  credit  with  the 
clearing  house  becomes  exhausted  and  perhaps  their 
reserve  in  the  vault  dwindles  toward  the  vanishing  point. 
Then  they  have  to  confront  the  possibility  that  they  will 
be  unable  to  liquidate  further  claims  against  them 
through  the  clearing  house.  This  would  be  practically 
a  confession  of  bankruptcy  and  would  result  in  closing 
the  doors  of  the  institution. 

Long  before  this  point  is  reached,  usually,  the  facts 
have  become  known  to  the  committee  which  has  the  man- 
agement of  the  clearing  house  and  it  is  obliged  to 
consider  what  will  be  the  effect  of  suspension  on  the  part 
of  the  bank  or  banks  which  are  in  the  condition  indicated. 
Their  fate  is  now  practically  in  the  hands  of  the  clearing- 
house managers,  for  they  can,  by  making  arrangements 


122  American  Banking 

to  relieve  the  weak  banks  of  the  necessity  of  paying  cash, 
lift  those  banks  out  of  their  dangerous  position  ami 
enable  them  to  retain  what  coin  and  currency  they  have 
left.  If  such  arrangements  are  made,  the  effect  is 
instantly  to  strengthen  confidence  in  the  weak  banks  and 
to  stop  the  drain  on  them.  The  facts  in  the  case  never 
become  known  and  the  weak  institutions  are  tided  over 
for  a  time  until  they  have  a  chance  to  look  around  and 
see  what  they  can  do. 

Will  the  clearing-house  managers  make  the  arrange- 
ments referred  to  I 

This  depends  entirely  upon  the  effect  they  believe  the 
suspension  of  the  given  bank  or  banks  ^^ill  have  upon  the 
community.  If  the  public  mind  is  in  an  agitated  condi- 
tion, so  that  the  suspension  of  one  or  more  banks  will 
lead  to  a  run  on  the  others,  it  is  to  the  interest  of  the 
banks  as  a  whole  to  hold  up  the  weak  brethren.  So 
also,  if  large  business  interests  are  likely  to  become 
embarrassed  through  the  tying  up  of  their  funds  in  a 
weak  bank,  support  of  that  bank  is  a  desirable  plan.  If 
times  are  normal,  business  confidence  is  high,  and  a 
bank's  suspension  will  affect  only  a  relatively  small  num- 
ber of  people  the  clearing-house  managers  will  probably 
calmly  say  to  the  weak  institution  that  the  best  thing  it 
can  do  is  to  close  up  and  go  out  of  business. 

Because  of  the  fact  that  such  decisions  are  not  always 
wisely  taken,  because  clearing-house  organizations  are 
local  onlj'-,  and  because  of  the  public  character  of  the 
function  thus  exercised,  the  Federal  Eeserve  Act  pro- 
vided for  federal  reserve  banks  whose  main  purpose  it 
is  through  the  rediscount  process  already  described  to 
relieve  banks  that  are  in  difficulties  and  thus  to  afford 
some  regular  and  steady  means  of  accommodation  other 
than  the  clearing  house.     The  new  banks  when  fully 


Clearing  Houses  123 

rooted  will  therefore  naturally  take  over  more  and  more 
of  the  clearing-house  function  just  set  forth, 

* '  Cleaking-House  Cektificates  ' ' 

There  have  been  many  times,  in  the  past  half  century, 
when  the  clearing-house  managers  have  practically  been 
called  upon  to  exercise  the  rediscount  function  of  a  cen- 
tral banking  mechanism  by  making  arrangements  to 
enable  an  embarrassed  bank  or  banks  to  get  past  a  danger 
point.  Of  course  such  weak  banks  had  a  substantial 
amount  of  assets.  They  were  not  perfectly  rotten  or 
they  would  have  gone  out  of  existence  before.  The  trou- 
ble with  them  was  not  that  they  liad  no  property  but  that 
they  had  no  adequate  cash  and  could  not  convert  their 
property  into  cash  owing  to  the  condition  of  stringency 
in  the  market.  If,  however,  other  banks  which  had  claims 
upon  them  were  willing,  instead  of  being  paid  in  cash, 
to  be  paid  in  titles  to  assets  or  property,  the  drain  of 
money  from  the  weak  banks  would  be  stopped.  They 
could  then  pay  their  debts  to  other  banks  by  giving  them 
titles  to  part  of  their  assets. 

This  necessitated  some  preliminary  arrangements. 
The  clearing-house  managers  have  usually  under  such 
conditions  authorized  banks  which  needed  assistance  to 
bring  securities  or  connnercial  paper  to  them  for  exam- 
ination. Then,  if  the  securities  and  paper  were  found  to 
be  of  good  quality,  the  clearing-house  managers  issued 
to  the  bank  or  banks  that  needed  aid  ''clearing-house 
certificates"  equal  to  75  per  cent  of  the  face  value  of  the 
securities  left  with  them.  Thus,  if  a  bank  brought  in 
100  bonds  of  $1,000  each  in  value  and  these  bonds  were 
approved,  the  bank  would  receive  $75,000  in  clearing- 
house certificates.  It  would  take  these  certificates, 
leaving  its  bonds  in  trust  with  the  clearing-house  com- 


124  American  Banking 

mittee,  and  when  claims  against  it  were  presented  by 
other  banks  it  would  pay  them  in  clearing-house  certifi- 
cates. A  heavy  interest  was  charged  by  the  clearing- 
house committee  for  the  issue  of  these  certificates  and 
this  made  it  desirable  for  the  bank  which  had  obtained 
the  accommodation  to  liquidate  as  soon  as  possible,  take 
its  securities  home  again  and  retire  the  certificates.  This 
has  taken  a  longer  or  shorter  time  according  to  the  degree 
in  which  the  bank  had  become  involved  and  the  difficulty 
it  had  in  realizing  on  its  assets.  Clearing-house  com- 
mittees have,  in  time  of  extreme  distress,  gone  even 
further  and  drawn  coin  from  the  reserves  of  the  strong 
banks  in  order  to  build  up  the  reserves  of  the  weaker 
ones  sufficiently  to  tide  them  over  a  run  originating  with 
frightened  depositors,  giving  clearing-house  certificates 
to  the  strong  banks  in  lieu  of  the  coin  thus  taken. 

Certificates  an  Extreme  Remedy 

Of  course  the  issue  of  clearing-house  certificates  in 
this  way  was  an  extreme  remedy  intended  to  meet  a 
peculiar  set  of  conditions.  The  banks  of  the  United 
States  resorted  to  this  remedy  on  several  different  occa- 
sions in  order  to  relieve  panic  and  banking  difficulties. 
The  last  such  occasions  were  in  1907  and  1914  when  an 
immense  volume  of  clearing  house  certificates  was  issued 
for  the  purpose  of  enabling  the  banks  to  liquidate  their 
obligations.  The  effect  was,  in  every  case  when  the 
scheme  was  tried,  to  give  the  public  the  impression  that 
the  banks  were  now  banded  together  for  mutual  protec- 
tion and  that  everj^  bank  was  practically  as  strong  as  the 
combined  banks  of  the  community.  This  helped  to  stop 
the  runs  on  the  banks  and  to  bring  about  a  more  placid 
state  of  affairs. 

The  success  that  has  attended  the  use  of  clearing- 


Cleai'iny  Houses  125 

house  certificates  has  in  years  past  led  some  persons  to 
propose  plans  whereby  the  use  of  such  certificates  should 
be  rendered  easy  and  the  banks  should  be  encouraged  to 
put  them  out  whenever  they  seemed  to  be  desirable.  The 
effect  of  such  a  step  of  course  would  be  the  same  as  that 
experienced  by  the  individual  who,  because  a  strong 
stimulant  helped  him  on  one  occasion  repeats  the  dose 
every  day  and  thus  becomes  habituated  to  it,  thereby  los- 
ing its  beneficial  effect.  It  is  obvious  that  the  success 
of  the  clearing-house  idea  has  been  found  entirely  in  the 
fact  that  in  the  main  the  banking  system  was  sound  and 
that  all  that  was  needed  was  a  plan  for  massing  the 
combined  strength  of  all  the  banks  behind  any  weak 
institutions  that  might  otherwise  have  gone  to  the  wall. 
It  is  well  to  remember  that  the  application  of  this  extreme 
means  of  relief  in  such  a  way  as  to  make  it  commonplace 
and  to  lead  the  banks  to  look  for  it  whenever  they  get 
into  the  slightest  trouble  would  take  away  the  benefit 
otherwise  likely  to  accrue.  In  spite  of  these  considera- 
tions however,  the  commercial  panic  of  1907  led  the 
United  States  to  take  a  step  in  the  direction  of  the 
habitual  use  of  clearing-house  certificates  or  something 
analogous  thereto. 

"Emergency  Notes" 

This  step  was  taken  in  1908  when  the  country  had  been 
thoroughly  alarmed  by  the  disastrous  panic  of  the  pre- 
ceding year  and  had  not  fully  recovered  from  its  effect. 
There  was  a  demand  for  some  currency  legislation  that 
would  make  it  possible  for  the  country  to  get  a  sufficient 
supply  of  circulating  medium  in  times  of  panic  or  strin- 
gency. After  a  long  struggle  in  Congress  during  the 
winter  of  1907-1908,  the  currency  law  of  1908,  known  as 
the  Aldrich-Vreeland  Act,  was  enacted. 


126  American  Banking 

This  law  provided  that  so-called  "national  currency 
associations"  might  be  organized  by  any  number  of 
banks  not  less  than  10  whose  joint  capitals  amounted  to 
not  less  than  $5,000,000.  These  associations  were  author- 
ized to  receive  from  the  constituent  banks  commercial 
paper  up  to  30  per  cent  of  the  combined  capital  of  the 
banks,  or  bonds  and  other  securities  up  to  a  gross  total 
not  exceeding  75  per  cent  of  the  combined  capital.  Then 
the  associations  were  entitled  to  apply  to  the  Secretary 
of  the  Treasury  for  notes  and  the  Secretary  was  author- 
ized to  issue  such  notes  to  the  association  demanding 
them.  The  idea  was  that  the  association  would  then 
apportion  these  notes  to  the  banks  that  wanted  them  and 
these  banks  would  use  them  in  pajdng  their  debts  to  other 
banks  or  in  satisfying  the  demands  of  depositors. 

The  act  also  provided  for  leaving  bonds  of  approved 
kinds  issued  by  states,  counties,  municipalities,  etc.,  with 
the  Secretary  of  the  Treasury  and  receiving  from  him 
in  exchange  notes  up  to  90  per  cent  of  the  value  of  such 
bonds  deposited  with  him.  Banks  could  get  notes  in 
this  way  on  their  own  individual  responsibility  and  with- 
out joining  a  national  currency  association.  A  heavy 
tax,  running  up  as  high  as  10  per  cent  per  annum,  was 
imposed  on  the  notes  thus  issued  and  they  were  to  be  an 
emergency  or  panic  currency. 

This  was  the  principle  of  the  clearing-house  certificate 
carried  a  step  further  and  employed  for  the  purpose  of 
creating  a  special  kind  of  note  which  could  be  generally 
used.  It  was  a  defective  expedient,  theoretically,  because 
it  retained  the  idea  of  a  special  security  behind  notes  in 
the  form  of  bonds  while  it  loaded  down  the  process  of 
issuing  notes  based  on  commercial  paper  with  so  hea^y 
a  tax  that  it  would  be  only  under  special  circumstances 
that  a  borrower  could  afford  the  use  of  the  notes. 


Clearing  Houses  127 

The  banks,  however,  did  not  like  the  provisions  of  the 
law  and  at  the  start  were  especially  antagonized  by  the 
fact  that  there  was  no  way  for  a  bank  to  get  out  of  a 
national  currency  association  when  it  had  once  got  in. 
It  had  to  stay,  and  would  presumably  have  to  take  what- 
ever in  the  way  of  joint  responsibility  for  ''emergency 
notes"  might  be  meted  out  to  it  by  the  other  banks  in 
the  organization.  For  these  reasons,  no  notes  were 
taken  out  by  national  currency  associations  prior  to  1914, 
the  year  of  the  European  war. 

War  Finance 

In  1914,  however,  on  the  sudden  outbreak  of  war  in 
Europe,  the  banks  were  driven  to  make  use  of  the  Aldrich- 
Vreeland  notes.  Upon  the  outbreak  of  the  war,  it  was 
at  once  evident  to  all  that  very  striking  changes  would 
result  in  every  department  of  business  life.  There  was 
no  knowledge  of  the  strategy  or  probable  methods  to  be 
employed  by  any  of  the  belligerents,  and  the  general 
attitude  of  the  business  community  was  based  upon  the 
assumption  that  commerce  would,  for  a  time  at  least, 
become  nearly  impossible.  As  a  corollary  to  that  assump- 
tion, there  prevailed  the  belief  in  many  circles  that 
American  indebtedness  to  foreign  countries  would  have 
to  be  liquidated  in  cash,  and  that  this  process  would 
result  in  draining  away  from  the  United  States  a  cor- 
responding amount  of  gold. 

It  was  natural,  therefore,  that  the  first  phenomenon 
of  the  war  should  be  the  suspension  of  dealings  which  it 
was  believed  would  promote  this  gold  movement,  or 
would  cause  more  serious  trouble  in  any  direction  than 
would  otherwise  be  inevitable.  The  closing  of  the  prin- 
cipal stock  exchanges  of  the  country  almost  immediately 
upon  the  definite  announcement  that  the  war  was  una- 


128  American  Banking 

voidable  was  thus  dictated  by  two  considerations:  (1) 
the  belief  that  prices  for  stocks  and  other  securities 
would  be  reduced  to  a  point  so  low  as  to  bring  about  the 
repurchase  of  the  securities  by  Americans,  who  would 
then  be  obliged  to  pay  for  them  in  gold;  (2)  the  belief 
that,  in  consequence  of  this  reduction  of  prices,  many 
bank  loans  based  upon  securities  would  have  to  be 
''called,"  thereby  bringing  about  failures  and  incident- 
ally assisting  in  the  movement  of  specie  out  of  the 
country. 

In  the  case  of  the  cotton  exchanges,  it  was  at  once  per- 
ceived that  the  cotton  crop,  which  is  so  largely  produced 
for  export,  could  not  now  move  abroad  with  any  degree 
of  facility,  and  that  the  demand  for  cotton  weuld  undoubt- 
edly be  slack.  The  very  fact  of  the  war,  therefore, 
implied  heavy  reductions  in  the  price  of  cotton,  and  the 
closing  of  the  cotton  exchanges  was  a  measure  of  self- 
preservation  on  the  part  of  the  operators,  who  decided 
to  protect  themselves  against  the  inevitable  failures 
which  would  result  from  the  fulfillment  of  existing  con- 
tracts at  very  low  prices.  To  close  the  exchanges  would 
result  in  gaining  time,  and  would,  therefore,  enable 
operators  to  meet  their  maturing  obligations,  besides 
perhaps  affording  an  opportunity  for  actual  recovery  in 
cotton  prices. 

This  very  fact,  however,  of  the  closing  of  the  exchanges 
and  the  consequent  removal  of  any  other  established 
method  of  determining  prices  for  standard  securities 
and  for  a  staple  like  cotton  involved  most  profound  and 
far-reaching  effects.  The  exchanges  had  closed  in  previ- 
ous years,  but  never  for  the  reasons  which  now  controlled 
them.  That  they  should  close  because  of  the  fear  of 
failure  and  the  loss  of  gold  implied  a  serious  danger  of 
disaster  which  appealed  powerfully  to  the  public  mind, 


Clearing  Houses  129 

and  which  presented  a  problem  that  could  not  be 
explained  away.  The  fact  that,  coincident  with  this  clos- 
ing of  the  exchanges,  international  trade  was  practically 
suspended  for  several  days,  and  was  seriously  inter- 
rupted for  several  weeks,  until  British  vessels  assumed 
virtual  control  of  the  North  Atlantic,  tended  greatly  to 
increase  the  public  anxiety.  It  formed  apparently  good 
ground  for  the  suspension  of  business  operations  and  for 
the  non-fuliillment  of  contracts,  even  when  the  very  diffi- 
cult conditions  did  not  themselves  compel  a  recourse  to 
such  methods.  The  fact  that  foreigTi  countries  had 
adopted  legislation  deferring  the  date  when  debts  need 
be  paid  or  contracts  fulfilled,  although  not  paralleled 
here,  produced  a  sjTiipathetic  influence  upon  business  in 
the  United  States,  which  practically  resulted  in  the  par- 
tial or  tentative  adoption  of  a  somewhat  similar 
relaxation  of  commercial  requii*ements  in  many  indus- 
tries and  branches  of  trade. 

Even  without  the  suspension  of  certain  classes  of  trad- 
ing throughout  the  country,  partially  due  as  it  was  to 
the  frenzied  demand  of  European  holders  of  American 
investments  for  money,  the  strain  thrown  upon  our  banks 
as  a  result  of  the  great  change  in  conditions  would  have 
been  enormous.  The  closing  of  the  exchanges,  as  already 
seen,  had  relieved  matters  to  some  extent  by  enabling 
the  banks  to  avoid  the  calling  of  loans,  and  thereby  to 
avoid  the  necessity  of  forcing  customers  into  liquidation, 
with  the  resultant  disastrous  effect  upon  themselves.  But 
on  the  other  hand,  the  suspension  of  operations  and  the 
corresponding  loss  by  the  public  would,  it  was  felt,  tend 
to  the  hoarding  of  legal-tender  money. 

In  order  to  meet  this  situation,  the  banks  in  many  of 
the  large  financial  centers  sought  to  limit  specie  pay- 
ments,  taking   out   emergency   currency   and   clearing- 


130  American  Banking 

house  certificates  for  the  purpose  of  meeting  their  indebt- 
edness to  the  public  and  to  one  another.  The  national 
currency  associations,  which  had  numbered  only  eighteen 
up  to  the  beginning  of  the  war,  rapidly  increased  until 
they  aggregated  forty-four;  and  prompt  preparations 
were  made  in  Washington  for  suppljang  emergency  cur- 
rency, under  the  terms  of  the  Federal  Reserve  Act,  to 
any  such  association  as  might  need  the  notes. 

At  the  same  time,  practically  all  the  clearing-house 
associations  of  the  larger  cities  arranged  for  the  issuing 
of  certificates.  Congress,  still  further  to  facilitate  the 
work,  adopted  on  August  4  and  15  measures  amenda- 
tory to  the  Federal  Eeserve  Act,  which  had  itself 
amended  and  extended  the  Aldrich-Vreeland  law.  Under 
these  latest  amendments,  very  much  greater  latitude  was 
given  for  the  issuing  of  currency,  and  the  cost  of  such 
issues  was  reduced  by  lowering  the  rates  of  taxation  col- 
lected upon  such  emergency  issues.  These  acts  practically 
gave  free  range  to  the  taking-out  of  emergency  bank 
notes,  and  during  the  weeks  succeeding  their  adoption, 
and  prior  to  the  opening  of  the  new  federal  reser\"e  banks, 
more  than  $350,000,000  was  issued,  the  ultimate  amount 
of  the  issues  aggregating  $380,000,000. 

MOEATOEIA 

War  finance  emphasized  in  a  striking  way  the  device 
of  legal  holidays  or  moratoria  for  the  protection  of  hard- 
pressed  banks.  A  moratorium  is  a  governmental  decree 
altering  the  terms  of  commercial  contracts  so  as  to  give 
the  debtor  a  legal  right  to  delay  meeting  an  obligation. 
Such  schemes  for  avoiding  disaster  were  resorted  to  fully 
by  many  countries,  both  peaceful  and  belligerent,  at  the 
outbreak  of  the  European  War.  During  the  panic  of 
1907,  the  governors  of  a  few  states  proclaimed  banking 


I 


Clearing  Houses  131 

holidays  of  several  weeks'  duration  to  enable  banks  to 
adjust  themselves  to  the  critical  conditions. 

Other  Associative  Activities 

As  noted  in  an  earlier  section  of  this  chapter,  the  banks 
of  the  country  have  attained  a  certain  amount  of  joint 
action  along  lines  other  than  those  growing  out  of  the 
f  clearing-house  associations  or  out  of  any  legislative  pro- 
visions. The  American  Bankers'  Association  has  done 
good  work  by  bringing  about  an  interchange  of  thought 
among  bankers  with  reference  to  banking  problems,  by 
supporting  or  criticizing  proposed  legislation  affecting 
the  banks,  and  by  bringing  the  banks  together  in  certain 
ways  for  mutual  safety  and  protection. 

While  such  associations  have  no  binding  character, 
they  do  tend  as  already  suggested  to  cany  further  the 
joint  efforts  which  are  exemplified  in  clearing-house 
associations,  and  to  bring  bankers  into  closer  relations 
generally  with  one  another.  They  also  tend  to  stimulate 
and  promote  uniformity  of  practice  in  regard  to  banking 
methods  and  to  make  the  better  banldng  methods  in 
vogue  in  various  parts  of  the  country  apply  in  other 
places  where  their  introduction  would  otherwise  be  con- 
siderably slower.  They  have  the  further  effect  of  making 
the  problems  of  certain  groups  of  banks  known  to  other 
banks  and  thereby  tend  to  bring  about  good  relations 
between  national  and  state  banks  and  banks  of  all  classes 
on  the  one  hand  and  trust  companies  on  the  other. 

It  is  probably  true  that  banking  has  a  more  uniform 
code  of  ethics  and  of  practice  than  any  other  occupation 
of  a  commercial  character.  This  is  the  result  of  the 
movement  toward  association  and  co-operation  in 
banking. 


132  American  Banking 

TEST  QUESTIONS 

1.  How  do  associative  efforts  in  banking  compare  with  sim- 
ilar efforts  in  other  lines  of  business? 

2.  What  is  a  clearing  house  ? 

3.  How  is  it  organized? 

4.  Explain  the  process  of  clearing  in  a  clearing  house. 

5.  How  are  balances  settled  at  a  clearing  house  ? 

6.  What   is  the   business   significance   of  a   clearing-house 
report  ? 

7.  Why  does  the  New  York  Clearing  House  have  special 
significance  for  the  entire  country? 

8.  Explain  the  provisions  made  by  the  Federal  Reserve  Act 
for  a  national  clearing  system. 

9.  How  can  a  clearing  house  assist  banks  that  are  hard 
pressed  ? 

10.  What  are  clearing-house  certificates?    Just  how  are  they 
issued  and  used? 

11.  What  important  services  besides  clearing  does  a  clearing 
house  perform? 

12.  What  is  a  moratorium? 


CHAPTER  X 
bank  organization  and  administration 

Organizing  the  Bank 

As  has  beeu  seen  in  a  former  section,  the  modern  bank 
is  usually  organized  as  a  corporation.  This  implies  the 
existence  of  all  the  features  of  corporate  organization 
which  exist  in  the  case  of  other  concerns.  There  must 
be  a  specified  number  of  incorporators  and  these  incor- 
porators must  elect  officers  and  carry  on  business  in  a 
certain  way.  Probably  an  idea  of  how  banks  are  organ- 
ized under  appropriate  legislation  in  the  United  States 
can  best  be  obtained  by  studying  the  organization  of  a 
bank  under  the  National  Bank  Act. 

The  National  Bank  Act,  for  reasons  which  will  later 
be  detailed,  makes  certain  requirements  concerning  the 
amount  of  capital  that  banks  located  in  towns  or  cities 
must  have.  It  also  makes  certain  special  requirements 
that  need  not  be  considered  save  in  outline.  We  will 
endeavor  merely  to  set  forth  those  features  of  national 
bank  organization  which  are  essential  and  characteristic. 

The  fundamental  requirement  in  organization  is  the 
contribution  of  an  actual  paid-up  capital  by  a  given 
number  of  persons,  set  at  not  less  than  five  in  the 
National  Act.  Any  five  persons  may  enter  into  articles 
of  association,  and  when  their  application  for  a  certificate 
of  organization  is  approved  by  the  comptroller  of  the 
currency  they  may  begin  business.  The  organization  cer- 
tificate must  specify  the  title,  location,  amount  of  capital 

133 


134  American  Banking 

stock  of  the  bank  and  number  of  shares  into  which 
divided,  the  shareholders,  and  the  object  of  the  certifi- 
cate, all  of  which  as  already  stated  must  receive  the 
approval  of  the  comptroller.  The  requirement  of  the 
National  Act  is  that  the  capital  stock  of  each  association 
shall  be  divided  into  shares  of  $100  each,  which  are  to 
be  deemed  personal  property  and  transferable  on  the 
books  of  the  association. 

The  concern  is  actually  organized  by  the  election  of 
at  least  five  directors  who  hold  office  for  one  year  and 
are  elected  by  the  shareholders  at  a  meeting  to  be  held 
at  any  time  before  the  association  is  authorized  to  begin 
business.  The  directors  are  obliged  to  own  at  least  ten 
shares  of  the  capital  stock  of  the  bank,  unless  the  capital 
is  below  $25,000,  in  which  case  each  must  own  at  least 
five  shares.  Each  shareholder  has  one  vote  for  each 
share  of  stock  and  may  vote  in  person  or  by  proxy. 

Payment  of  Capital 

At  least  50  jDcr  cent  of  the  capital  stock  of  every 
national  bank  has  to  be  paid  in  before  the  concern  is 
authorized  to  begin  business.  The  remainder  must  be 
paid  in  installments  of  not  less  than  10  per  cent  each,  at 
least  once  each  month.  This  would  mean  that  the  concern 
would  actually  have  paid  in  to  it,  in  cash,  the  total  face 
value  of  its  capital  stock  by  the  expiration  of  five  months 
from  the  time  the  bank  is  organized.  Some  of  the  state 
laws  are  even  more  stringent  upon  this  point,  requiring 
that  the  entire  capital  stock  must  be  paid  in  before  the 
bank  is  authorized  to  begin  business. 

The  National  Bank  Act  (and  every  other  banking  law 
which  is  properly  drawn)  is  particularly  careful  to  spec- 
ify the  requirement  that  the  capital  stock  shall  be  paid 
up  entirely  unimpaired  at  an  e'arly  date  in  the  bank's 


Bank  Organization  and  Administration         135 

career.  In  times  past,  under  loose  banking  legislation, 
banks  have  sometimes  opened  with  little  or  no  capital, 
simply  accepting  the  notes  of  the  shareholders  for  the 
bulk  of  the  subscriptions  they  made  and  expecting  to  get 
funds  through  direct  deposits  made  in  the  bank  by  outside 
customers.  Such  a  policy  has  invariably  led  to  disaster, 
because  the  concern  was  usually  unable  to  collect  the 
installments  due  on  the  notes  of  the  shareholders  when 
the  funds  were  needed  and  so  had  little  to  fall  back  upon ; 
or,  as  was  frequently  the  case,  the  same  bad  judgment 
which  permitted  the  organization  of  the  concern  on  a 
purely  credit  basis  and  \vithout  actual  capital,  led  to  the 
making  of  bad  loans,  the  failure  to  compel  the  stock- 
holders to  pay  in  their  installments,  etc.,  so  that  as  a 
result  the  banks  quickly  came  to  an  unfortunate  end.  At 
the  present  time,  the  actual  early  payment  of  the  full 
capital  stock  in  cash  is  a  universal  prerequisite  to  engag- 
ing in  any  sound  banking  business. 

Officers  of  the  Bank 

The  directors  of  the  bank,  although  fundamentally 
responsible  for  and  charged  with  the  control  of  the  bank 
to  which  they  belong,  are  not  its  officers  in  the  technical 
sense  of  the  term.  A  set  of  officers  must  be  chosen  by 
the  directors,  and  to  them  is  given  the  duty  of  actually 
managing  and  carrying  on  the  business  of  the  bank. 

The  PEEsroENT 

The  National  Bank  Act  requires  that  one  of  the  direct- 
ors, to  be  chosen  by  the  full  board  of  directors,  shall  be 
named  president  of  the  board.  The  duties  of  such  a 
president  vary  considerably  with  the  size  of  the  bank, 
its  location,  and  other  factors  in  the  situation.  The  presi- 
dent may  be  merely  an  ornamental  figure,  or  he  may  be 


136  American  Banking 

the  actual  working  head  of  the  organization,  looking 
after  the  details  of  its  business  and  in  a  large  way  direct- 
ing what  goes  on.  In  any  bank  of  considerable  size,  his 
work  is  that  of  general  superintendence  rather  than  that 
of  particular  attention  to  given  transactions. 

Within  recent  years,  the  duties  of  the  president  have, 
however,  become  much  more  clearly  defined  by  the  courts 
than  they  formerly  were.  "When  he  is  the  active  head 
of  the  bank  he  has  all  the  authority  which  law  and  custom 
confer  on  the  head  regardless  of  the  name  of  the  office. ' ' 
In  many  cases,  the  president  has  risen  to  his  position 
through  various  subordinate  places  and  is  familiar  with 
the  workings  of  the  different  departments.  At  times, 
however,  the  president  is  largely  a  figure-head  and  has 
no  technical  knowledge  of  the  affairs  of  the  institution. 
In  other  cases  he  may  devote  himself  to  blocking  out  lines 
of  policy,  investigating  general  conditions  in  the  bank, 
and  instituting  needed  economies  and  changes  of  organ- 
ization. An  important  function  performed  by  the  presi- 
dent is  that  of  developing  methods  for  extending  business 
and  enlarging  the  number  of  depositors.  In  the  large 
cities,  the  establishment  of  good  relations  with  other 
banks,  some  of  which  may  become  depositors — usually 
large  ones — is  important.  The  bank  has,  to  a  certain 
extent,  a  legal  liability  for  the  conduct  of  its  president, 
and  thus  next  to  the  board  of  directors  he  is  the  import- 
ant factor  in  the  concern. 

Vice  PBEsroENTS 

A  bank  may  have  one  or  more  vice  presidents  who  may 
act  successively  in  the  absence  of  the  president  or  of  other 
vice  presidents.  Their  legal  status  is  not  precisely  the 
same  as  that  of  the  president,  depending  in  part  upon 
the  by-laws  of  the  institution  as  well  as  upon  its  cus- 


Bank  Organisation  and  Administration         137 

toms.  In  a  good  many  cases,  vice  presidents  are  elected 
largely  for  the  purpose  of  recognizing  various  large 
stockholding  interests  and  with  the  idea  that  they  may 
be  made  better  acquainted  or  better  satisfied  with  the 
management  if  they  are  thus  represented.  Some- 
times the  names  of  these  men  are  used  on  letterheads 
and  in  advertisements  to  add  prestige  to  the  bank,  or 
thej^  are  employed  as  solicitors  of  new  business.  Or, 
again,  the  vice  presidents  may  be  actual  working  officers 
of  the  bank  and  although  called  by  the  name  of  vice 
president  they  may  really  perform  the  duties  of  other 
officers,  the  title  of  vice  president  being  merely  a  com- 
pliment and  an  indication  of  their  importance,  usually  in 
relation  to  the  stockholders,  in  the  conduct  of  the  bank. 

It  is  not  desirable  that  an  institution  should  have  many 
officers  who  are  purely  ornamental  or  nominal  or  titular. 
Hence  the  National  Bank  Act  provides  for  only  one  vice 
president,  giving  to  the  board  of  directors  the  power 
"to  appoint  a  president,  vice  president,  cashier,  and 
other  officers,  define  their  duties,"  etc. 

''Other  Officers" 

The  ''other  officers"  who  are  thus  generally  referred 
to  in  the  national  banking  law  vary  a  great  deal  from 
bank  to  bank,  their  number,  the  distribution  of  duties 
among  them,  etc.,  being  left  to  be  determined  in  the  indi- 
vidual case  as  is  necessary  under  varying  conditions  of 
business,  bank  organization,  location,  and  the  like.  It  is 
possible,  however,  to  indicate  the  chief  types  of  officers 
who  are  usually  found  in  banks.  Of  these  the  cashier  is 
the  most  important,  being  often  the  real  executive  head 
of  the  bank.  Next  in  rank  to  him  comes  the  paying 
teller,  whose  duty  it  is  to  disburse  funds  upon  demand. 
The  receiving  teller  who  takes  in  deposits  and  performs 


138  American  Banking 

other  duties  ranks  usually  after  the  paying  teller.  In 
larger  banks,  a  note  teller  also  exists  and  has  charge  of 
letters  and  deals  with  promissory  notes  liquidated  at  the 
bank.  In  some  banks,  a  discoimt  clerk  is  employed, 
although  in  the  smaller  ones  he  usually  is  identical  with 
the  note  teller,  both  kinds  of  duty  being  performed  by  one 
man. 

These  various  officers  may  have  large  staffs  under 
their  direction,  the  size  of  such  staffs  depending  upon 
the  business  of  the  bank,  the  magnitude  of  its  operations, 
etc.  But,  whether  their  staffs  be  large  or  small,  or 
whether  the  work  in  each  division  be  done  practically  by 
one  man,  the  tj^^e  of  organization  is  the  same.  Subordi- 
nate, however,  to  these  "officers"  are  a  number  of 
employees  who  facilitate  their  work.  Probably  the  most 
important  of  sucli  subordinate  divisions  is  the  bookkeep- 
ing department,  which  is  usually  in  charge  of  the  head 
bookkeeper  assisted  by  such  clerks  and  subordinate  work- 
ers as  may  be  needed.  There  may  be  various  other 
departments,  such  as  a  special  credit  bureau  in  the  bank, 
and  a  collection  department.  This  is  largely  a  matter  of 
individual  organization  and  depends  on  the  bank  for 
its  details. 

Chaeting  the  Organization 

The  suggested  executive  and  clerical  organization  for 
federal  reserve  banks  recommended  by  the  Federal 
Reserve  Board  (Fig.  2)  contains  valuable  organization 
ideas  for  other  institutions.  A  simple  outline  showing 
the  chief  officers  and  the  leading  functional  lines  of  work 
in  an  average-sized  bank  is  shown  in  Figure  3.  These 
charts  may  serve  as  the  basis  for  an  actual  organization. 


FIG.  2 

EXECUTIVt  AND  CLEGICAL  OEGANIZATION 

TEDEGAL  BESEEVE  BANKS 
FEDERAL  RESERVE    BOARD 


\SSti\ I^SSTl 


n 


Bank  Organization  and  Administration         139 


Stockholders 


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Fig.  3. — Suggested  Organization  for  a  Bank 

Cashier's  Duties 

As  is  well  noted  by  Mr.  Albert  S.  Bolles,  ''The  duties 
and  authority  of  a  cashier  have  been  clearly  determined 
by  practice  and  legal  decision."  The  cashier  must  give 
a  bond,  to  be  signed  by  one  or  more  sureties  or  by  a 
surety  company  whose  fee  may  or  may  not  be  paid  by  the 
bank  itself.  The  cashier,  holding  office  next  after  the 
higher  officials  of  the  bank,  has  an  annual  tenure  which, 
however,  is  terminable  at  the  pleasure  of  the  appointing 
power. 


140  American  Banking 

It  is  the  duty  of  the  cashier  to  keep  a  record  of  the 
directors'  meetings  and  to  sign  the  certificates  of  stock, 
the  checks  drawn  on  other  banks,  and  the  drafts  and 
notes  that  need  indorsement  before  sending  them  away  to 
another  bank  for  collection.  The  cashier  is  also  heavily 
burdened  in  the  larger  banks  with  the  general  conduct 
of  the  bank's  correspondence.  Besides  this  he  has  gen- 
eral oversight  of  the  internal  affairs  of  the  institution, 
the  payment  of  expenses,  the  condition  of  depositors' 
accounts,  etc.  It  may  be  advisable  to  give  the  cashier 
the  aid  of  one  or  more  assistant  cashiers  who  are  then 
subordinate  to  him  and  take  over  such  portions  of  the 
work  as  he  may  intrust  to  them.  He  is  primarily  responsi- 
ble for  all  the  actual  transactions  after  lines  of  policy 
have  been  blocked  out  by  the  president  and  vice  president. 
He  passes  on  all  new  deposit  accounts,  signs  drafts  for 
the  disbursement  of  funds,  and  is  custodian  of  the  com- 
pany's assets  and  the  securities  contained  in  the  vaults. 

In  trust  companies,  there  is  usually  an  officer  called  a 
secretary  who  performs  the  functions  of  a  bank  cashier 
in  keeping  the  minutes  of  the  board  meetings,  attending 
to  correspondence,  etc.,  while  the  officer  called  cashier  in 
a  bank  is  known  as  the  treasurer  in  most  trust  com- 
panies. 

Paying  Teller 

The  paying  teller,  having  general  charge  of  the  cus- 
tody and  disbursement  of  funds,  exercises  the  primary 
executive  control  of  the  outward  flow  of  money.  In  order 
to  focus  responsibility  as  far  as  possible,  therefore,  an 
effort  is  usually  made  to  confine  the  business  of  the  pay- 
ing teller  to  one  person,  but  in  the  larger  concerns  there 
may  be  more  than  one,  for  reasons  of  necessity.  The 
paying  teller  cashes  the  checks  which  are  presented  for 


Bank  Organization  and  Administration         141 

payment  and  his  principal  occupation  consists  in  paying 
such  checks.  This  makes  it  necessary  for  him  to  be  famil- 
iar with  the  signatures  of  the  depositors,  and  also  to  know 
much  about  the  condition  of  their  accounts.  Otherwise, 
he  might  pay  checks  that  were  in  excess  of  the  amount 
to  the  credit  of  the  drawer  of  the  check.  Where  checks 
are  presented  by  persons  other  than  the  drawer,  it  is 
necessary  to  look  carefully  at  the  indorsement  and  to 
make  sure  that  the  persons  who  present  the  checks  are 
entitled  to  the  funds  and  that  the  indorsements  are  such 
as  fully  to  protect  the  bank. 

The  paying  teller's  accounts  necessarily  show  the 
amount  on  hand,  and  when  this  has  been  combined  with 
the  day's  receipts  and  the  day's  payments  subtracted 
therefrom,  the  resulting  balance  is  equal  to  the  amount  of 
cash  on  hand  and  in  bank.  This  it  is  desirable  to  show  in 
some  detail. 

In  case  a  depositor  desires  to  secure  a  draft  on  some 
distant  institution  or  to  have  his  check  certified  (so  that 
it  becomes  an  obligation  of  the  bank  and  the  person 
receiving  it  is  directly  informed  that  it  is  acknowledged 
as  such  by  the  institution),  it  is  the  duty  of  the  paying 
teller  to  arrange  these  matters. 

Receiving  Teller 

The  work  of  the  receiving  teller  supplements  that  of 
the  paying  teller.  He  has  charge  of  the  receiving  of 
deposits  with  the  bank.  According  to  general  practice, 
the  constituent  elements  of  these  deposits  are  listed  by 
the  depositor  himself  on  a  ''deposit  ticket"  which  he 
fills  out  with  his  name  and  the  amount  of  coin,  currency, 
and  checks  issued  by  various  persons  or  firms  which  he 
desires  to  deposit  to  his  own  credit  in  the  bank.  The 
depositor  is  provided  with  a  bank  book  in  which  are 


142  American  Banking 

recorded  as  a  lump  sum  the  totals  of  the  deposits  made 
by  him.  He  hands  both  bank  book  and  deposit  slip  to 
the  receiving  teller,  accompanying  them  of  course  with 
the  sum  in  coin,  currency,  checks,  or  other  negotiable 
papers,  which  he  wishes  to  deposit. 

It  is  the  duty  of  the  receiving  teller  to  accept  these 
checks  and  currency  and  then  to  examine  them  in  com- 
parison with  the  deposit  slip  in  order  to  make  sure  that 
the  coin  and  currency  is  in  the  amount  specified,  that  it 
represents  good  money  free  of  counterfeits,  and  that  the 
checks  are  properly  indorsed.  In  the  event  that  the 
depositor  obtains  credit  by  leaving  his  own  note  with 
the  bank,  the  amount  of  such  note  is  credited  to  him  in 
his  deposit  book  just  as  would  have  been  done  with  coin 
or  currency.  The  receiving  teller,  like  the  paying  teller, 
must  be  able  to  recognize  the  signature  of  the  depositor, 
since  it  is  his  duty  to  make  sure  that  the  depositor's  own 
signature  is  placed  upon  the  back  of  checks,  drafts,  etc., 
requiring  such  indorsement,  in  order  that  the  depositor 
may  become  immediately  responsible  in  the  event  of  a 
check  being  returned.  The  writing  up  or  balancing  of 
pass  books  (bank  books)  is  sometimes  done  by  the  receiv- 
ing teller  but,  if  possible,  should  be  done  by  someone  else 
in  order  to  test  the  accuracy  of  the  work  of  the  receiving 
teller. 

Note  Tellee 

Every  bank  holds  many  promissory  notes  which  it  has 
discounted  or  which  represent  loans  it  has  made  to  bor- 
rowers. Every  bank  also  has  a  certain  number  of  prom- 
issory notes  which  have  been  left  with  it  by  individuals 
for  collection  in  order  that  they  may  receive  credit  for 
the  amounts  as  soon  as  the  notes  have  been  cashed  or 
paid  by  those  who  originally  made  them.    These  notes 


Bank  Organization  and  Administration         143 

are  placed  in  the  custody  of  the  note  teller  and  it  is  his 
'duty  to  enter  remittances,  give  notices  to  makers  of 
notes,  attend  to  the  protesting  of  unpaid  notes,  etc. 

The  note  teller  keeps  track  of  the  notes  in  his  custody 
by  making  entries  in  a  book  kept  for  that  purpose, 
arranging  them  alphabetically.  If  collateral  security  is 
attached  to  the  note  held  by  the  bank,  the  kind  and  amount 
of  such  security  is  also  listed  by  the  note  teller  and  when 
the  note  is  paid  and  the  collateral  returned,  the  owner 
signs  his  name  upon  a  line  corresponding  to  tliat  on 
which  the  description  of  the  collateral  appears,  thus  indi- 
cating that  he  has  received  back  the  securities  which  he 
left  for  the  protection  of  the  bank.  When  a  note  is  paid 
the  note  teller  stamps  it  ''Paid"  and  returns  it  to  the 
maker,  who  may  then  destroy  it  if  he  chooses. 

Many  persons  make  their  notes  payable  at  the  bank  with 
which  they  keep  their  accounts,  and  they  may  then  be  paid 
by  the  bank  and  charged  to  their  account  so  that  it  is 
not  necessary  for  them  to  trouble  themselves  about  any- 
thing further  than  maintaining  their  credit  at  a  sum 
which  will  easily  cover  all  the  obligations  that  come  in 
for  liquidation. 

In  the  event  that  a  note  is  not  paid,  the  note  teller  may 
present  it  through  a  notary  public  at  the  place  of  business 
of  the  maker  or  wherever  it  is  made  payable.  Then,  in 
the  event  of  a  refusal  to  pay,  the  note  is  attached  to  a 
printed  legal  form,  called  a  protest,  describing  the  facts 
in  the  case,  and  a  notice  is  sent  to  all  indorsers  informing 
them  of  their  liability.  The  notary  is  usually  an  officer 
and  employee  of  the  bank,  but  there  is  a  distinction 
between  his  duties  as  a  bank  official  and  his  function  as 
a  public  officer,  the  latter  taking  precedence  of  or  super- 
seding the  former  whenever  necessary. 


144  American  Banking 

The  Discount  Clerk 

Where  for  convenience,  owing  to  extensive  business,  a 
distinction  is  made  between  the  note  teller  and  the  dis- 
count clerk,  the  function  of  the  latter  is  to  keep  a  record 
of  notes  offered  to  the  bank  or  of  notes  immediately  dis- 
counted. When  record  has  been  made  of  the  maker's 
name,  the  names  of  the  indorsers,  the  place  of  payment, 
the  time  due,  the  amount  of  the  discount,  and  the  net 
proceeds,  the  discount  clerk  takes  charge  of  the  notes 
themselves,  putting  them  away  in  proper  form  for  preser- 
vation. 

It  is  usual  also  to  have  the  discount  clerk  actually 
take  charge  of  the  bills  receivable  of  the  bank,  handing 
them  to  the  note  teller  (whose  duties  have  already  been 
described)  upon  the  day  when  they  mature,  and  leaving 
it  to  the  latter  to  see  after  their  collection.  The  discount 
clerk  stores  the  bills  receivable  in  a  special  part  of  the 
bank  vault,  and  it  is  customary  for  officers  desirous  of 
examining  the  paper  to  have  it  shown  to  them  by  the 
discount  clerk,  thus  maintaining  the  latter 's  personal 
responsibility  for  the  various  items  of  paper  passing 
through  his  hands. 

It  falls  to  the  discount  clerk  in  the  larger  banks  to 
notify  borrowers  of  the  result  of  their  applications  for 
loans  or  discounts  after  the  directors  or  officers  of  the 
institution  have  passed  upon  them  favorably  or  unfa- 
vorably, y 

Bank  Bookkeeping 

The  study  of  bank  bookkeeping  is  an  elaborate  subject 
in  itself  and  cannot  be  dealt  with  in  detail  at  this  point. 
While  there  is  a  strong  tendency  to  simplify  the  records 
of  banks  as  far  as  possible,  the  larger  institutions  are 


Bank  Organization  and  Administration         145 

obliged  to  employ  a  tolerably  extensive  and  complex 
system.  All  banks  keep  certain  books  for  their  own  par- 
ticular use.  One  of  these  is  the  stock  book,  in  which  are 
recorded  the  names  of  the  shareholders  and  the  nmnber 
of  shares  held  by  each.  In  a  collection  register  are  kept 
records  of  all  collections,  whether  of  checks  on  banks  in 
the  same  city  or  of  those  of  banks  in  other  cities.  In  a 
book  or  series  of  books  usually  known  as  the  discount 
register  the  various  notes  discounted  are  recorded,  with 
the  name  of  the  maker  and  indorser,  the  date  of  the  note, 
time  of  payment,  number  of  payments  made,  etc. 

The  ledgers  of  the  bank,  often  classified  alphabetically 
and  sometimes  divided  into  country  and  city,  in  town 
and  out  of  town,  are  intended  to  record  the  business  of 
the  bank  with  every  depositor.  It  has  been  seen  how 
the  depositor  leaves  with  the  receiving  teller  a  ticket 
verified  by  the  latter  upon  which  he  has  classed  the  dif- 
ferent items  of  coin,  currency,  checks,  drafts,  etc.,  which 
he  has  left  with  the  bank  for  his  credit.  In  the  same  way 
it  has  been  seen  that  in  dra^\^.ng  out  funds  he  usually 
gives  a  check.  Many  banks  post  these  checks  and  deposit 
tickets  directly  into  the  ledger,  crediting  the  depositor 
with  what  he  has  left  at  the  bank  and  debiting  him  with 
the  amount  of  the  checks  which  he  has  deposited  for  cash- 
ing or  which  he  has  given  to  others  who  have  themselves 
deposited  them  or  had  them  cashed. 

In  a  general  ledger,  the  accounts  relating  to  the  busi- 
ness of  the  bank  as  such — its  capital  and  surplus,  its 
profit  and  loss,  the  value  of  its  bonds,  its  real  estate,  its 
fixtures,  etc. — are  carried.  The  general  ledger  thus  con- 
tains the  gross  results  of  the  bank's  business  massed 
together  in  such  a  way  as  to  show  aggregates  of  transac- 
tions. 

Many  minor  records  of  detailed  books  of  statements, 


146  American  Banking 

etc.,  are  kept  by  different  banks  according  to  the  nature 
of  their  business.  But,  in  every  bank,  the  general  scheme 
of  accounting  is  necessarily  in  accordance  with  the  same 
main  plan. 

TEST  QUESTIONS 

1.  What  provisions  does  the  National  Bank  Act  make  concern- 
ing the  capitalization  of  a  bank? 

2.  What  provisions  does  the  Act  make  concerning  the  officers 
of  a  bank? 

3.  Who  are  the  chief  officers  of  a  bank? 

4.  What  are  the  duties  of  the  cashier?  the  paying  teller?  the 
receiving  teller?  the  note  teller?  the  discount  clerk? 

5.  What  are  the  chief  books  of  a  bank? 


CHAPTER  XI 
capitai,  and  reserves 

The  Bank  as  a  Going  Concern 

When  it  has  been  decided  to  organize  a  bank  in  a 
community,  several  questions  will  at  once  present  them- 
selves. The  first  is  whether  the  capital  to  be  employed 
should  be  of  a  given  amount.  This  is,  broadly  speaking, 
the  problem  of  the  amount  of  banking  capital  needed 
in  a  community  under  given  conditions.  What  is  needed 
is  ultimately  dependent  upon  the  activity  of  the  business 
of  the  community,  for  the  proportionate  amount  of  capi- 
tal which  should  be  devoted  to  banking  as  compared  with 
other  occupations  can  be  definitely  determined.  Experi- 
ence only  can  show  what  amount  of  banking  capital  is 
actually  needed  in  any  given  place  at  any  given  moment 
and  how  this  capital  should  be  divided  among  the  differ- 
ent classes  of  banks. 

In  every  place,  there  is  a  gradual  ebb  and  flow  of  bank- 
ing capital.  Sometimes  too  many  institutions  are  in 
existence,  and  then  some  are  gradually  driven  out  or 
absorbed  by  the  others.  The  weaker  banks  in  such  a 
community,  finding  that  they  are  not  earning  sufficient 
returns  to  make  it  worth  while,  may  decide  to  give  up  the 
struggle,  and  transfer  their  assets  to  the  other  banks.  In 
the  same  way,  if  there  is  too  little  banking  capital  in  a 
community,  the  effect  is  to  cause  a  strain  on  the  capital 
already  employed,  as  a  result  of  which  either  too  many 
loans     are     granted     and     a     bank    becomes     unduly 

147 


148  Ainerican  Banking 

"extended,"  as  the  phrase  goes — i.  e.,  has  too  many  loans 
outstanding  for  the  amount  of  reserve,  and  hence  is  in  a 
dangerous  condition — or  else  it  has  to  turn  away 
would-be  borrowers  who  have  perhaps  offered  very  fair 
security.  Or  it  may  be  that  the  bank,  finding  business 
abundant,  raises  its  rate  of  interest  so  high  that  many 
borrowers  who  would  be  glad  to  get  accommodation  do 
not  find  that  it  is  worth  their  while  to  do  so.  As  a  result 
of  one  or  all  of  these  conditions,  there  may  be  a  demand 
for  a  new  bank.  The  question  whether  such  a  bank  will 
be  organized  is  in  practice  dependent  upon  the  ideas  of 
local  capitalists  as  to  the  amount  of  business  offering, 
the  rate  of  profit  that  is  being  made  by  existing  banks, 
and  other  factors  of  the  same  kind. 

In  general,  it  may  be  said  that  there  is  a  distinct  rela- 
tionship between  the  amount  of  the  capital  and  the  char- 
acter of  the  business  transactions  of  the  community.  A 
bank  with  $50,000  capital  would  not  do  well  in  Wall 
Street,  because  it  would  not  be  able  to  make  a  single  loan 
large  enough  to  meet  the  wants  of  the  average  borrower. 
A  bank  of  $1,000,000  would  not  do  well  in  the  country 
town  because  the  business  to  keep  that  amount  of  capital 
employed  would  not  offer  itself.  This  is  the  reason  why 
the  National  Bank  Act  attempts  to  regulate  in  a  very 
general  way  the  amount  of  a  bank's  capital  with  refer- 
ence to  the  size  of  the  place  in  which  it  is  located.  But 
within  the  broad  limits  set  by  this  or  any  other  law, 
there  is  a  large  field  in  which  the  conditions  of  business, 
the  judgment  of  the  organizers  of  the  bank,  and  other 
factors  of  similar  tv'pe  must  control. 

Creating  a  '' Surplus  " 

If  a  bank  starts  with,  say,  $100,000  capital,  this  does 
not  necessarily  mean  that  the  money  thus  contributed  is 


Capital  and  Reserves  149 

its  only  resource.  It  may  be  tliat  depositors  will 
promptly  leave  with  it  a  quantity  of  coin  or  currency,  in 
which  case  its  available  cash  means  for  carrying  on  busi- 
ness are  increased  to  a  corresponding  extent,  though  of 
course  correspondingly  subject  to  withdrawal  by  depos- 
itors at  any  time. 

The  bank,  however,  may  add  to  the  actual  capital  it 
employs  by  refraining  from  dividing  its  profits.  That  is, 
if  at  the  end  of  a  year  a  bank  finds  it  has  $20,000  in 
profits,  it  may  decide  to  divide  $5,000  as  dividends  and 
hold  the  other  $15,000  for  permanent  use  in  the  business. 
In  such  a  case,  although  the  funds  are  not  technically 
a  part  of  the  national  bank's  capital,  they  are  so  in  prac- 
tice. Thus,  a  bank  with  a  capital  of  $100,000  and  a 
surplus  of  $20,000,  is  in  the  same  position  so  far  as 
business  goes,  as  a  bank  with  $120,000  capital. 

The  surplus,  however,  has  a  different  legal  status  from 
the  capital.  The  National  Bank  Act  pro\ides  that  "the 
directors  of  any  association  may  semi-annually  declare 
a  dividend  of  so  much  of  the  net  profits  of  the  associa- 
tion as  they  shall  judge  expedient;  but  each  association 
shall,  before  the  declaration  of  a  dividend,  carry  one- 
tenth  part  of  its  net  profits  of  the  preceding  half  year 
to  its  surplus  fund  until  the  same  shall  amount  to  twenty 
per  centum  of  its  capital  stock."  This  means  that  the 
framers  of  the  National  Bank  Act  thought  it  was  desir- 
able to  have  a  surplus  of  at  least  20  per  cent  shown  by 
every  bank  before  the  whole  of  its  annual  profits  begin 
to  be  divided. 

There  is  a  good  reason  for  the  idea  in  the  fact  that  the 
surplus  acts  as  a  buffer  in  the  event  of  serious  loss  or 
the  failure  of  certain  assets  to  materialize  as  they  had 
been  expected.  In  the  case  of  the  $100,000  bank  with 
$20,000  surplus,  if  a  dishonest  cashier  disappears  with 


150  American  Banking 

$15,000  in  cash,  the  bank  is  still  left  with  its  capital  intact 
and  $5,000  of  additional  funds.  Had  the  bank  possessed 
no  surplus,  the  capital  would  have  been  impaired  to  the 
extent  of  $15,000,  and  the  result  would  have  been  a  neces- 
sary reorganization  for  the  purpose  of  either  reducing 
the  face  value  of  its  capital  stock  to  an  amount  corre- 
sponding to  the  reduced  net  assets  (in  this  case  $85,000) 
or  else  a  call  upon  the  stockholders  to  make  good  $15,000 
in  pro  rata  contributions  in  order  to  restore  the  capital  to 
its  face  amount.  There  are  other  reasons  why  it  may  be 
of  advantage  for  a  bank  in  the  national  system  to  have  a 
surplus,  but  these  are  of  a  more  special  and  technical 
sort  and  will  not  be  discussed  at  this  point. 

It  remains  to  be  added  that  many  banks  do  not  wait 
for  the  slow  process  of  accumulating  a  surplus,  but  when 
they  start  business  the  stockholders  put  in  a  paid-up 
surplus.  Thus  a  bank  may  start  with  $100,000  capital 
and  $100,000  surplus  instead  of  starting  with  $200,000 
of  capital.  Inasmuch  as  national  bank  stockholders  are 
by  law  liable  to  an  amount  equal  to  the  face  of  their  cap- 
ital stock  in  the  event  of  failure,  this  mode  of  organiza- 
tion curtails  the  liability  they  would  be  under,  as  with 
$100,000  of  capital  stock  and  $100,000  of  surplus  their 
joint  total  liability  is  only  $100,000  in  addition,  whereas 
had  they  started  with  $200,000  of  capital  their  joint  addi- 
tional liability  would  have  been  $200,000. 

Undwided  Peofits 

Most  banks  carry  on  their  statements  an  item  addi- 
tional to  capital  and  surplus  called  "undivided  profits." 
This  item  merely  represents  what  is  left  over  from  vari- 
ous periods  of  di^T.dend-pa}T.ng  at  which  the  amount  on 
hand  has  not  been  such  as  to  afford  an  even  distribution. 
Thus,  suppose  that  a  given  bank  with  $100,000  capital 


Capital  and  Reserves  151 

finds  at  the  end  of  a  year  that  it  has  $6,766  of  profits. 
It  might  declare  a  dividend  of  6.766  per  cent  but  it  is 
much  more  likely  to  declare  a  dividend  of  6  per  cent  and 
carry  the  remaining  $766  as  undivided  profits.  This 
would  not  account  for  the  fact  that,  in  some  banks,  the 
item  undivided  profits  becomes  very  large.  It  might  be 
expected  that,  if  the  matter  of  regularity  alone  were 
considered,  undivided  profits  would  be  divided  when- 
ever they  reached  a  figure  permitting  of  an  easy  division. 
The  fact  is  that  the  proprietors  of  bank  stock  prefer  to 
see  their  dividends  upon  a  level  basis  rather  than  fluctuat- 
ing from  year  to  year,  as  the  former  policy  gives  a  clearer 
and  better  idea  of  the  value  of  the  stock. 

These  undivided  profits,  therefore,  really  constitute  a 
fund  which  acts  as  a  reserve  for  the  purpose  of  equaliz- 
ing dividends.  Thus  if,  in  1900,  the  supposed  bank  found 
itself  with  $6,766  of  profits  and  the  following  year  with 
$5,234,  it  would  be  able  to  declare  a  flat  6  per  cent  divi- 
dend each  year,  which  would  be  much  better  for  the  value 
of  the  stock  than  to  divide  the  total  profit  each  year,  thus 
changing  the  percentage  each  time.  It  may  be,  however, 
that  a  bank  has,  year  after  year,  a  steady  excess  of 
profits  above  what  it  regards  as  its  normal  dividend  rate. 
In  that  event,  it  either  ultimately  raises  its  dividend  to 
correspond,  or  else  carries  the  accumulating  undivided 
profits  to  surplus  account,  which  practically  makes  them 
a  part  of  the  capital  of  the  bank  and  places  them  in  a 
position  to  pay  profits  additional  to  those  earned  on  the 
capital.  This  will  mean  that,  ultimately,  since  a  larger 
amount  of  funds  is  employed  in  the  business,  a  larger 
amount  of  profits  will  be  earned,  and  consequently  if  the 
hank  is  honestly  conducted  larger  ultimate  dividends  will 
be  realized. 

Conservatism    in    banking    indicates    the   wisdom   of 


152  American  Banking 

declaring  dividends  only  to  a  moderate  extent,  gradually 
enlarging  the  surplus  as  business  conditions  permit  of 
its  profitable  employment,  and  maintaining  a  small  fund 
of  undivided  profits  as  a  means  of  permitting  the  equali- 
zation of  dividends  over  profitable  and  unfortunate  years. 

Reserve 

To  be  classed  with  the  problems  relating  to  capital, 
surplus,  and  undivided  profits,  is  the  problem  of  reserve 
and  its  amount.  From  the  general  discussion  of  banking 
already  presented,  it  will  have  been  understood  that  the 
bank  must  always  keep  on  hand  an  amount  sufficient  to 
enable  it  tx)  meet  its  demand  obligations  at  sight  in  cash. 
As  was  then  pointed  out,  the  amount  thus  needed  varies 
a  good  deal  from  community  to  community  and  from 
bank  to  bank,  depending  upon  the  clientele  of  the  bank 
and  its  methods  of  business.  There  is  usually  a  given 
percentage  of  cash  as  compared  with  demand  liability 
which  is  considered  by  conservative  bankers  to  be  neces- 
sary for  their  protection  or  which  is  prescribed  by  law 
to  be  carried  in  any  case.  This  sum  is  usually  referred  to 
as  the  reserve,  or  the  ''lawful  money  reserve"  of  the 
bank.  Its  amount  is  supposed  to  indicate  the  danger 
line,  beyond  which  business  cannot  be  done  with  safety  to 
the  bank  and  its  customers.  How  to  maintain  the  reserve, 
what  are  the  conditions  that  govern  its  amount,  etc.,  are 
therefore  questions  which  receive  the  serious  attention  of 
eveiy  banker. 

The  National  Bank  Act,  in  its  anxiety  to  protect  the 
creditors  of  banks,  originally  laid  down  precise  rules  in 
reference  to  the  amount  of  reserve  to  be  carried  by  such 
institutions,  which  are  now  in  process  of  being  altered 
under  the  working  of  the  Federal  Resei've  Act.  The  old 
law  recognized  three  classes   of  cities;     (1)    ''central 


Capital  and  Reserves  153 

reserve  cities,"  which  are  three  in  number,  New  York, 
Chicago,  and  St.  Louis;  (2)  "reserve  cities,"  which  now 
number  forty-nine  and  are  places  of  moderate  size  scat- 
tered over  the  country;  (3)  outside  places,  which  include 
all  other  localities  in  which  banks  are  situated.  These 
last  are  usually  referred  to  as  ''country  banks,"  the 
term  being  used  even  if  they  are  situated  in  places  of 
considerable  size  which  have  not  been  ''designated"  as 
"central  reserve"  cities,  or  "reserve"  cities. 

Up  to  1913,  when  the  Federal  Reserve  Act  was  passed, 
the  law  provided  that  central  reserve  city  banks  should 
at  all  times  keep  on  hand  25  per  cent  of  their  outstanding 
deposits  in  the  form  of  legal-tender  money;  and  that 
reserve  city  banl^s  should  keep  on  hand  25  per  cent,  but 
that  they  migiit  be  allowed  to  deposit  one-half  of  this 
(121/2  per  cent)  with  central  reserve  city  banks.  Country 
banks  were  required  to  keep  on  hand  15  per  cent,  of 
which,  however,  3-5  (9  per  cent)  might  be  redeposited 
with  reserve  city  or  central  reserve  city  banks.  From 
this  it  will  be  seen  that,  at  any  time,  the  banks  of  New 
York,  Chicago,  and  St.  Louis  might  be  in  possession  of 
only  25  per  cent  of  their  outstanding  deposits,  and  at  the 
same  time  the  banks  of  a  large  number  of  other  important 
places  might  have  only  12i/^  per  cent  of  their  outstand- 
ing deposits  in  cash,  while  all  other  banks  might  have 
only  6  per  cent  of  their  outstanding  deposits  in  cash. 

Experience  indicated  that  in  ordinary  times  these 
reserves  were  entirely  adequate.  In  abnormal  times  the 
situation  was  totally  different.  The  local  bank  might  be 
heavily  drawn  upon  by  anxious  depositors,  in  which  case 
its  6  per  cent  of  cash  melted  quickly  away.  It  could  then 
call  upon  the  redeposits  it  had  made  with  other  banks,  but 
if  the  drain  was  severe,  even  these  did  not  last  long  and 
then  the  bank  could  get  relief  only  by  the  sale  of  its  assets 


154  American  Banking 

to  other  banks,  provided  tlie  latter  were  willing  to  buy 
them.  If  they  were  not  willing,  the  bank  had  to  suspend 
or  fail.  Upon  occasions  when  lack  of  confidence  was 
general  throughout  the  country,  many  banks  were  in 
that  condition  and  then  a  general  bank  suspension  usually 
supervened. 

Oeigin  of  Reserve  Grouping 

This  classification  of  banks,  with  the  accompanying 
permission  to  the  reserve  city  and  country  banks  to  rede- 
posit  their  reserves  in  the  way  just  discussed,  did  not 
arise  on  a  purely  haphazard  basis,  but  grew  out  of  the 
system  of  providing  for  domestic  exchange,  which  existed 
at  the  time  of  the  Civil  War,  when  the  National  Bank 
Act  was  passed.  Under  the  system  of  highly  diffused 
banking  which  then  existed,  it  had  been  found  necessary 
for  banks  throughout  the  country  to  keep  balances  with 
banks  at  certain  important  commercial  points  in  order 
to  afford  remittances  to  merchants.  The  proportions 
fixed  by  law  in  which  the  reserves  of  country  and  reserve 
city  banks  were  allowed  to  be  redeposited  are  said  to 
have  been  computed  as  the  result  of  an  investigation  of 
the  average  amount  of  such  balances  which  had  to  be 
continuously  kept  with  other  banks  by  outlying  institu- 
tions that  were  regularly  called  upon  to  provide  exchange. 
The  theory  involved  was  that,  inasmuch  as  a  balance  with 
another  bank  was  presumably  payable  on  demand,  it  was 
equivalent  to  cash  in  the  vaults  of  the  creditor  bank,  and 
should,  therefore,  be  classified  as  "reserves." 

There  may  have  been  some  basis  for  this  view  so  long 
as  the  accounts  referred  to  were  used  merely  for  pro- 
viding exchange.  While  that  was  the  case  the  redeposit 
of  reserves  merely  amounted  to  a  temporary  transfer, 
and  the  whole  basis  of  the  banking  assets  of  the  nation 


Capital  and  Reserves  155 

consisted  of  fluid  funds.  A  change  in  the  situation  was 
shortly  introduced.  Competition  among  central  reserve 
city  banks  set  in,  the  effort  of  the  different  banks  being 
to  obtain  as  large  ''out-of-town"  balances  as  they  could, 
in  order  that  they  might  get  whatever  benefit  arose  from 
the  holding  of  the  funds  and  that  they  might  draw  to 
themselves  the  incidental  business  likely  to  result  from 
the  maintenance  of  relations  with  country  banks  and 
others  which  might  have  funds  to  spare  or  business  to 
transact  in  the  cities. 

The  great  growth  of  stock  market  operations  after  the 
Civil  War  increased  this  competition,  because  it  shortly 
appeared  that  by  developing  the  call-loan  system,  it  was, 
in  ordinary  times,  safe  for  banks  in  central  reserve  cities, 
particularly  in  New  York,  to  make  large  loans  to  Stock 
Exchange  operators,  with  the  expectation  of  promptly 
calling  these  in  if  there  should  be  a  sudden  drain  upon 
them  from  their  country  correspondents.  In  other  words, 
the  country  bank  placed  its  funds  with  the  New  York 
(or  other  reserve  city)  bank;  this  New  York  bank  built 
up  a  large  "line"  of  demand  loans  to  stock  exchange 
operators;  the  operators  traded  on  the  strength  of  the 
credit,  and  when  called  upon  by  banks  to  liquidate  did  so 
by  selling  their  stocks  and  paying  their  loans,  where- 
upon the  banks  found  themselves  in  funds  with  which  to 
meet  the  demands  of  their  correspondents. 

Practical  bankers  and  students  of  the  theory  of  bank- 
ing agree  that  this  system  was  unsatisfactory.  In 
ordinary  times  when  conditions  were  prosperous,  there 
was  no  serious  shock  to  general  business  as  a  result  of  it, 
but  the  effect  was  to  produce  temporary  superabundance 
and  temporary  shortage  of  loans  in  the  stock  market, 
the  result  being  that  a  demand  for  money  in  the  interior 
of  the  country  meant  liigh  rates  of  interest  on  the  stock 


156  American  Banking 

exchange,  and  vice  versa.  The  worst  evil  in  the  situation 
lay  in  the  fact  that  there  was  a  constant  tendency  to 
inflate  stock  operations  and  to  raise  prices  thereby,  the 
result  being  that  as  the  maintenance  of  the  market 
became  more  and  more  difficult,  the  strain  on  the  banks 
was  increasingly  severe  and  their  indisposition  to  part 
with  funds  correspondingly  marked. 

Moreover,  in  times  of  panic  when  shrinkage  was  immi- 
nent, the  banks  found  it  impossible  to  get  their  ''reserve" 
funds  out  of  the  stock  market  securities  in  which  they 
were  practically  invested  through  the  call-loan  opera- 
tion, without  producing  so  severe  a  shrinkage  of  values 
as  to  cause  widespread  bankruptcy.  They  were,  there- 
fore, obliged  to  resort  to  suspension  of  specie  payments, 
and  often  did  so. 

Furthermore,  the  interior  institutions  in  times  of  stock 
market  activity  frequently  invested  large  quantities  of 
funds  (which  ought  to  have  been  kept  by  them  in  their 
own  vaults)  in  direct  loans  to  speculators  on  the 
exchanges,  their  desire  being  to  get  the  advantage  of  the 
high  rates  of  interest  which  were  prevailing  there  at 
that  time.  Undue  stimulation  to  speculative  operations 
and  undue  shortage  of  cash  throughout  the  country,  with 
a  highly  unstable  reserve  system,  was  the  result  of  this 
method  of  operating. 

Transfer  of  Reserves  under  New  Act 

In  the  Federal  Reserve  Act  it  was  recognized  that  the 
essential  remedy  was  the  transfer  of  all  reserve  funds 
from  institutions  which  were  in  danger  of  using  them  in 
investments  that  might  become  non-liquid  and  to  put 
them  in  the  hands  of  institutions  which  would  keep  them 
in  a  liquid  form,  using  them  only  for  the  objects  of 
strictly  commercial  banking.    The  Federal  Reserve  Act, 


Capital  and  Reserves  157 

therefore,  provided  that  after  three  years  nothing  should 
be  counted  as  reserves  by  any  member  bank  except  either 
cash  in  its  own  vault  or  a  deposit  with  the  federal  reserve 
bank  of  its  district.  While  there  was  no  express  pro- 
vision prohibiting  the  federal  reserve  bank  of  each 
district  from  paying  interest  on  balances,  it  was  the  evi- 
dent intent  of  the  Act  that  no  such  interest  should  be 
paid,  but  that  the  balances  with  federal  reserve  banks 
should  be  carried  there  without  any  inducement  or  stim- 
ulus to  member  banks  to  employ  them  for  the  purpose  of 
enhancing  their  income.  Pursuant  to  this  thought,  the 
Act  provided  that  immediately  upon  the  organization  of 
the  federal  reserve  banks  a  specified  amount  of  reserve 
should  be  transferred  to  these  banks,  another  specified 
amount  at  the  end  of  a  year  and  a  third  installment  a 
year  later.  At  the  end  of  three  years  the  whole  transfer 
would  have  been  effected. 

From  the  belief  that  by  massing  reserves  in  this  way 
and  making  them  really  available  for  the  purpose  for 
which  they  were  intended,  the  total  amount  of  money 
actually  required  to  be  held  for  the  purpose  of  safety 
would  be  much  smaller  than  heretofore,  the  Federal 
Reserve  Act  materially  cut  down  the  percentage  required 
by  law  to  be  held  by  member  banks,  reducing  it  to  18% 
of  demand  deposits  in  central  reserve  cities,  15%  in 
reserve  cities  and  12%  in  country  banlis.  The  Act  fur- 
ther provided  that  where  banks  held  time  deposits  upon 
which  thirty  days '  notice  could  be  exacted  by  the  member 
banks,  only  5%  of  the  outstanding  liability  need  be 
kept.  The  following  table  will  summarize  the  statements 
that  have  been  made  in  the  foregoing  pages  by  showing 
in  comparative  form  the  percentage  requirements  for 
bank  reserves  and  the  places  where  they  are  to  be  kept 
according  to  the  Federal  Reserve  Act : 


158 


American  Banking 


Classea  of  Bajiks 

Demand 
Deposits 

Time 
Deposits 

Country  banks   

12% 

15 

18 

5% 

Reserve  city  banks 

5 

Central  reserve  city  banks 

5 

The  amendments  of  June  21,  1917,  changed  the  reserve 
requirements  materially.  They  provide  for  the  im- 
mediate transfer  of  all  reserves  to  the  federal  re- 
serve banks.  This  means  a  greater  concentration  of  gold 
reserves  and  makes  possible  a  more  effective  control  of 
reserves  for  the  national  need.  Member  banks  are  no 
longer  required  to  maintain  legal  reserves  in  their  own 
vaults.  Each  bank  is  at  liberty  to  decide  for  itself  what 
its  local  requirements  may  be.  The  reserve  requirements, 
as  a  whole,  were  lowered  as  follows : 


Classes  of  Banks 

Demand 
Deposits 

Time 
Deposits 

Country  banks    

7% 
10 
13 

3% 

Reserve  city  banks 

3 

Central  reserve  city  banks 

3 

Another  significant  change  relates  to  the  accounting 
for  gold  and  notes,  particularly  as  between  the  bank  itself 
and  the  federal  reserve  agent.  It  authorizes  the  issue 
of  federal  reserve  notes  upon  the  security  of  gold  or  gold 
certificates,  and  provides  that  gold  or  gold  certificates 
held  by  the  federal  reserve  agent  as  collateral  security 
shall  be  counted  as  part  of  the  gold  reserve  which  the 
federal  reserve  bank  is  required  to  maintain  against  its 
notes  in  actual  circulation.  Such  gold  may  also  be  with- 
drawn from  beliind  notes  in  exchange  for  commercial 


Capital  and  Reserves  159 

paper,  and  its  transfer  to  deposit  reserve  account  cor- 
respondingly strengthens  the  deposit  protection  by  en- 
larging the  funds  technically  held  for  that  purpose. 

On  June  7, 1917,  the  Federal  Reserve  Board  authorized 
an  item  in  the  Consolidated  Weekly  Statement,  entitled 
"Gold  Held  with  Foreign  Agencies."  This  is  a  step  in 
line  with  the  practice  of  foreign  banks.  It  has  the  advan- 
tage of  avoiding  the  necessity  of  shipping  gold  over  sea, 
while  the  use  made  of  the  money  as  reserve  is  identical 
to  that  with  which  it  would  have  been  put  had  the  metal 
been  actually  and  physically  present  in  the  vaults  of  the 
reserve  banks  themselves.  Under  this  arrangement  such 
gold  is  held  in  the  foreign  bank  as  "earmarked"  gold, 
subject  to  the  orders  of  the  reserve  system.     - 

Effect  of  Fedekai^  Eesekve  Act 

To  sum  up  this  whole  matter,  it  mil  be  seen  that  the 
effect  of  the  Federal  Reserve  Act  upon  the  reserves  of 
the  country  will  be  merely  that  of  (1)  reducing  the  per- 
centage of  required  reserve;  (2)  rendering  this  reserve 
really  liquid  by  requiring  that  it  be  funds  with  the  federal 
reserve  bank,  the  latter  to  be  either  cash  or  investments 
in  short-term  commercial  paper;  and  (3)  eliminating  the 
permission  to  count  balances  with  other  commercial  banks 
as  reserve. 

There  has  been  a  great  deal  of  misunderstanding  and 
misapprehension  regarding  the  operation  of  these  pro- 
visions. It  is  believed  in  some  quarters  that  the  pro- 
visions of  the  Act  prevent  banks  from  keeping  balances 
with  other  banks  or  prevent  them  from  obtaining  their 
usual  interest  on  deposits  with  such  banks,  or  in  some 
way  interfering  with  their  operations.  Nothing  of  the 
kind  appears  in  the  Federal  Reserve  Act  or  can  be 
inferred  from  it.    The  Act  merely  repeals  the  older  pro- 


160  American  Banking 

visions  of  law  which  allow  balances  carried  with  other 
banks  to  count  as  reserve.  There  is  no  reason  whatever 
why  any  bank  which  wishes  to  do  so  should  not  carry  any 
balance  it  chooses  with  another  bank  at  any  rate  of 
interest  it  can  obtain. 

Others  have  asserted  that,  while  the  requirements  of 
the  Federal  Reserve  Act  are  not  open  to  any  direct  criti- 
cism for  the  reason  just  stated,  they  are  in  effect  a  hard- 
ship upon  the  member  banks  because  they  result  in 
imposing  upon  them  an  additional  reserve  requirement, 
the  apparent  reduction  in  reserves  not  being  real,  because 
in  practice  (to  take  care  of  their  necessary  exchange  and 
collection  operations)  the  member  banks  are  obliged  to 
go  on  keeping  funds  in  New  York  and  other  cities.  There 
would  be  force  in  this  statement  if  there  were  not,  as 
will  shortly  be  shown,  pro\^sion  in  the  Federal  Reserve 
Act  for  carrying  on  the  collection  and  exchange  business 
of  the  member  banks  through  the  Federal  Reserve  Bank. 
Since,  however,  that  has  been  fully  provided  for,  the 
necessity  of  keeping  balances  with  commercial  banks  in 
other  cities  is  eliminated  and  there  is  no  reason  why  a 
member  bank  should  not,  if  it  chooses  to  do  so,  dispense 
'udth  practically  all  collection  and  exchange  accounts  kept 
elsewhere,  merely  retaining  its  account  -with  its  own  fed- 
eral reserve  bank  and  expecting  that  bank  to  perform  all 
necessaiy  transactions  for  it.  Until  the  state  banks 
enter  the  federal  reserve  system  or  provision  is  made 
for  collecting  items  drawn  on  them  through  federal 
reserve  banks,  there  may  be  some  basis  for  the  statement 
that  the  maintenance  of  certain  accounts  with  other  banks 
for  collection  purposes  is  necessary.  This,  however,  \n\\ 
probably  disappear  rapidly  as  time  goes  on. 

The  effect  of  the  reserve  provisions  of  the  Federal 
Reserve  Act  upon  the  profits  and  the  prosperity  of  the 


Capital  and  Reserves  161 

member  banks  deserves  careful  consideration.  As  is 
well  known,  an  important  item  in  the  cost  of  operating 
a  bank  is  the  necessity  of  keeping  a  satisfactory  reserve 
on  hand  and  the  impossibility  of  realizing  anything  from 
the  amount  of  money  thus  "tied  up."  For  example,  if  a 
bank  finds  from  experience  that  it  must  always  have  on 
hand  $100,000  in  its  vaults,  that  means  that  it  loses  at 
5%  interest,  $5,000  a  year,  or  that  $5,000  a  year  is  the 
expense  to  it  of  maintaining  its  resei^ve.  The  effect  of 
the  reserve  requirements  of  the  Federal  Reserve  Act 
upon  this  aspect  of  banking  expense  is,  therefore,  impor- 
tant. 

Let  us  take  the  case  of  the  country  bank  under  the  older 
conditions.  Such  a  bank  may  be  supposed  to  have  had 
outstanding  $100,000  of  demand  deposit  accounts. 
Against  this  it  had  to  hold  15%  reserve  or  $15,000.  Of 
this  $15,000,  three-fifths  or  $9,000  might  be  carried  as  a 
** balance"  with  a  bank  in  some  reserve  city.  The  reserve 
city  bank  would  usually  allow  2%  interest  on  this  bal- 
ance, or,  in  this  case,  $180  per  annum.  Under  the  new 
system  the  bank  has  to  hold  a  reserve  of  7%,  or  $7,000 
instead  of  $15,000.  This  7%  is  all  cash  or  balance  with 
federal  reserve  banks  and  is  non-interest  bearing.  The 
bank  would,  therefore,  lose  the  $180  interest  which  it 
earned  on  its  reserve  balance  under  the  old  system.  On 
the  other  hand,  there  would  be  set  free  for  other  uses 
$8,000  (the  difference  between  $15,000  and  $7,000).  If 
the  prevailing  rate  of  interest  in  the  community  were  6%, 
this  $8,000  would  yield  $480,  leaving  the  bank  a  hand- 
some little  profit,  or  if  the  $8,000  were  used  as  a  reserve 
to  sustain  outstanding  deposit  to  credits  or  loans,  it 
would  sustain  presumably  a  little  more  than  the  $7,000 
held  as  a  reserve  against  $100,000  of  deposit  accounts. 
This  would  mean  that  deposit  loans  to  the  extent  of 


162  American  Banking 

$114,000  could  be  added  to  those  already  outstanding, 
provided  the  bank  could  find  borrowers.  If  it  did  find 
them,  its  income  would  be  6%  on  $114,000,  or  $6,840,  so 
that  it  would  be  a  very  large  gainer  by  the  change. 

Restoking  the  Reserve    . 

The  problem  of  the  average  banker  in  ordinary  times, 
so  far  as  reserves  are  concerned,  is  merely  to  provide 
for  keeping  his  reserve  up  to  at  least  the  amount  required 
by  law  and  in  some  cases  at  a  much  higher  level,  which 
he  has  found  from  experience  to  be  desirable.  The 
Federal  Reserve  Act  makes  provision  for  enabling  him  to 
do  this. 

Suppose  a  banker  should  find  his  reserve  running  down. 
No  banker  can  ever  keep  a  reserve  so  large  as  to  resist 
the  combined  drafts  of  depositors  if  they  become  alarmed 
and  insist  on  pajnuent.  When  the  reserve  drops  below 
the  danger  mark,  the  banker  must  seriously  consider  how 
to  get  back  again  to  safety.  He  has  two  courses  open  to 
him.  One  of  these  is  to  sell  some  of  his  assets  to  other 
banks.  In  ordinary  times  this  is  not  difficult  and  is 
effected  by  the  process  of  rediscounting  at  federal  reserve 
banks  or  elsewhere  already  described,  or  perhaps  by  the 
outright  sale  of  bonds  or  stocks  which  the  banker  may 
have  on  hand.  In  either  case  the  banker  gets  the  right  to 
draw  on  some  other  bank  or  on  his  reserve  bank,  and  he 
liquidates  immediate  demands  for  cash  with  the  credit 
thus  obtained  or  with  cash  which  he  obtains  by  means  of 
such  credit.  Another  way  for  him  to  proceed  is  by  ceas- 
ing to  discount  or  lend.  If  he  does  that,  with  the  lapse 
of  days  there  comes  in  to  him  the  proceeds  of  maturing 
loans.  These  proceeds  may  be  p^id  in  cash  or  in  claims 
on  other  banks.    In  either  case,  he  gets  the  means  out  of 


Capital  and  Reserves  163 

which  he  is  able  to  raise  his  cash  reserve  to  such  a  point 
that  he  is  enabled  to  go  ahead  with  additional  loans  or 
the  buying  of  new  paper  offered  to  him. 

The  process  of  turning  away  business  in  this  way 
requires  some  self-denial  and  is  likely  to  involve  the 
giving  of  offense  to  some  customers  who  cannot  under- 
stand why  they  should  not  be  allowed  credit  as  usual. 
In  order  to  avoid  the  necessity  of  absolutely  refusing 
loans  to  customers,  the  banker  may  adopt  an  alternative 
expedient  intended  to  discourage  them  from  insisting 
upon  getting  credit.  This  is  the  raising  of  his  rate  of 
discount. 

Eate  of  Discount 

The  rate  of  interest  or  discount  charged  by  the  bank 
is  influenced  by  a  number  of  factors,  but  essentially 
depends  upon  the  same  conditions  that  determine  any 
other  rate  of  interest  in  a  community.  Fundamental 
among  these  is  the  question — what  return  can  be  obtained 
by  the  use  of  capital  in  business?  If  capital  can  be  made 
to  yield  20  per  cent  annually  in  legitimate  business,  and 
if  loanable  funds  are  scarce,  there  is  no  reason  why  the 
rate  of  interest  should  not  be  raised  to  some  point 
that  will  equitably  divide  the  20  per  cent  between  the 
borrower  or  business  man  who  applies  or  invests  the  cap- 
ital and  the  banker  who  supplies  or  furnishes  it.  Of 
course  if  loanable  capital  is  abundant  and  its  owners  do 
not  care  directly  to  invest  it  in  business,  this  point  will 
be  lower  than  otherwise,  while,  conversely,  if  the  com- 
munity is  made  up  of  active  business  men  each  of  whom 
uses  his  funds  freely  in  his  own  business,  the  rate  of 
interest  may  rise  to  a  point  very  near  the  average  level 
of  business  profit. 

Supposing,  however,  that  such  an  average  level  has 


164  American  Banking 

been  established  in  any  community,  there  will  neverthe- 
less be  a  deeided  difference  in  rates  of  interest  charged 
by  the  banker  to  different  borrowers.  The  man  who  pre- 
sents security  that  is  not  of  first-class  type  will  have  to 
pay  a  higher  rate  than  the  man  whose  security  is  abso- 
lutely "gilt-edged."  In  the  same  way,  the  bank  may 
make  a  higher  charge  for  demand  loans  than  for  time 
loans,  etc.,  the  rate  being  varied  to  suit  the  given  condi- 
tions. 

Now,  in  addition  to  these  factors  controlling  the  rate 
of  interest,  the  banker  may  arbitrarily  increase  his  rate 
whenever  he  finds  that  his  reserve  is  running  near  the 
danger  mark.  In  every  community  there  are  numbers 
of  borrowers  whose  necessity  for  loanable  funds  differs 
a  good  deal  in  intensity.  Some  of  these  borrowers  are 
just  upon  the  line  of  doubt  as  to  whether  it  is  worth  their 
while  to  borrow  or  not.  A  man  may  see  a  chance  for  a 
business  transaction  in  which  he  can  make,  say,  8  per  cent. 
If  he  has  to  pay  8  per  cent  for  the  capital  engaged  in  the 
transaction,  there  will  be  no  reason  for  undertaking  it. 
The  competent  banker  in  close  touch  with  the  business 
situation  in  his  community  has  a  fair  idea  where  this 
level  of  profit  with  reference  to  the  transactions  of  that 
community  is  located.  He  can  then  adjust  his  rate  of 
interest  or  discount  in  such  a  way  as  to  exclude  a  good 
many  borrowers  who  will  not  want  their  accommodation 
when  they  are  informed  that  they  must  pay  a  substan- 
tial price  in  order  to  secure  it.  Or  the  banker  may  raise 
his  rate  for  granting  a  certain  specified  kind  of  accommo- 
dation ;  e.  g.,  a  loan  on  collateral  security  of  a  given  type 
— and  by  so  doing  he  may  succeed  in  shutting  out  a  good 
many  would-be  borrowers  who  want  him  to  take  col- 
lateral, when  he  thinks  that  this  kind  of  borrowing  is 
being  overdone. 


Capital  and  Reserves  165 

Relieving  Haed-peessed  Banks 

Having  thus  considered  the  way  in  which  the  individual 
bank  manages  its  affairs  when  reserves  shrink,  and  the 
means  by  which  it  restores  them  either  through  redis- 
counts or  through  changes  in  the  rate  of  discount,  we 
may  now  give  special  attention  to  the  working  of  these 
principles  in  the  federal  reserve  system,  which  is 
intended  to  assist  and  relieve  its  member  banks  in  case 
of  necessity.  The  essential  and  primary  purpose  of  the 
system  is  that  of  performing  the  operation  of  rediscount. 

Discount,  as  already  seen,  is  the  transaction  in  which 
a  bank  accepts  from  a  customer  an  obligation  running 
for  a  specified  length  of  time,  and  advances  to  this  cus- 
tomer the  amount  of  the  obligation,  minus  the  interest  for 
the  period  for  which  the  funds  are  advanced.  This  pre- 
liminary deduction  of  interest  is  termed  discount  and  the 
note  has  been  discounted  when  it  is  left  with  the  bank  by 
one  who  wishes  to  obtain  the  immediate  use  of  funds. 
When  a  bank  possessed  of  such  notes,  and  itself  desiring 
funds,  presents  these  notes  to  another  banli  in  order  to 
get  an  advance,  the  operation  is  called  a  rediscount.  The 
notes  in  that  case  are  rediscounted  by  the  bank  which  pre- 
sents them,  and  they  are  discounted  by  the  bank  which 
takes  them  and  advances  funds  in  exchange.  This  proc- 
ess of  rediscount  is  usually  accompanied  by  that  of 
indorsement.  That  is  to  say,  the  bank  which  presents 
the  note  for  rediscount  indorses  it,  thereby  guaranteeing, 
that  it  will  be  paid  at  maturity. 

In  Europe,  generally,  the  process  of  rediscounting  is  a 
common  one  and  banks  resort  to  it  as  a  customary  inci- 
dent in  their  operations.  In  the  United  States  there  has 
long  been  a  prejudice  against  rediscounting,  it  being  felt 
that  the  situation  in  wliich  a  bank  is  obliged  to  resort  to 


166  American  Banking 

another  in  this  way  is  not  one  which  reflects  credit  upon 
it.  It  has  been  frequently  the  custom,  therefore,  for  a 
bank  needing  funds  to  borrow  them  upon  its  OAvn  direct 
obligation,  or  that  of  members  of  its  board  of  directors, 
and  secure  such  obligation  by  the  deposit  of  collateral. 
Thus,  for  example,  if  a  bank  in  Utica,  New  York,  desired 
to  borrow  of  a  New  York  City  bank,  it  might  do  so  by 
simply  giving  its  own  note  for  the  amount,  or  its  directors 
might  obtain  loans  at  the  New  York  City  bank,  with  the 
understanding  that  such  loans  were  for  the  use  of  the 
Utica  institution. 

The  Federal  Reserve  Act  is  intended  to  make  redis- 
counting  a  natural,  customary,  and  safe  method  of  liqui- 
dating paper  and  equahzing  the  stock  of  reserve  money 
of  the  community  among  the  different  banks.  The  pri- 
mary function  open  to  the  federal  reserve  banks,  as 
already  stated,  is  that  of  rediscount,  but  they  are  limited 
in  the  performance  of  this  function  to  their  o^vn  mem- 
bers. They  are,  in  other  words,  authorized  to  rediscount 
the  paper  of  their  member  banks,  thereby  enabling  the 
various  members  to  obtain  reserve  credits  in  place  of 
the  obligations  of  their  customers  whenever  they  desire. 

It  should  be  noted  that  the  effect  of  this  process  is 
quite  different  from  that  of  extending  a  ''line"  of  credit 
in  the  way  already  described  as  being  customary  among 
the  banks  of  the  United  States.  Where  such  a  general 
line  of  credit  is  established,  there  is  no  definite  date  of 
maturity  for  the  loans.  The  bank  extending  it  may  have 
taken  the  precaution  to  grant  the  credit  with  a  definite 
maturity,  and  may  demand  payment  at  such  maturity. 
This,  however,  does  not  necessarily  mean  that  the  bank 
thus  called  upon  to  pay  has  any  automatic  means  of  pro- 
adding  itself  with  resources.  In  the  case  where  the  bank 
which  needs  funds  rediscounts  a  piece  of  commercial 


Capital  and  Reserves  167 

paper,  it  entirely  parts  with  that  paper,  and  the  payment 
of  the  obligation  when  due  falls  upon  the  person  who 
originally  made  the  paper.  The  discounting  bank  has 
merely  guaranteed  that  there  will  be  no  default.  If  the 
maker  of  the  paper  is  practically  certain  to  be  in  posses- 
sion of  funds  at  the  maturity  of  the  paper,  liquidation 
at  the  time  named  is  assured. 

The  question  then,  in  carrying  on  a  system  of  redis- 
count, is  that  of  making  certain  that  the  paper  thus 
presented  is  of  a  kind  that  will  liquidate  itself.  Conse- 
quently, the  Federal  Reserve  Act  provides  that  only  such 
paper  shall  be  eligible  for  rediscount  as  grows  out  of 
commercial,  agricultural,  or  industrial  transactions,  and 
the  regulations  of  the  Federal  Reserve  Board  have  inter- 
preted this  to  mean  that  the  only  paper  eligible  for 
rediscount  is  that  which  grows  out  of  an  actual,  live 
transaction  involving  a  sale  of  goods  in  commerce,  indus- 
try, or  agriculture.  Assuming  this  definition  to  be 
actually  lived  up  to,  the  necessary  consequence  is  that  the 
.  paper  is  certain  to  be  liquidated  at  maturity,  if  the  maker 
himself  is  solvent.  In  other  words,  the  great  mass  of 
such  rediscounted  paper  is  as  liquid  as  the  general  busi- 
ness of  the  community  itself.  If  the  community  has 
suffered  some  general  disaster,  there  may  be  a  condition 
of  suspension  of  payments,  in  which  case  no  paper  would 
be  liquid.  If  this  is  not  the  case,  then  it  may  be  assumed 
that  the  function  of  the  federal  reserve  bank  has  been 
merely  to  take  from  banks  which  had  extended  their 
credit  too  far  and  which  needed  funds,  a  certain  part  of 
the  commercial  paper  they  had  discounted  and  to  give 
them  the  funds  in  exchange. 


168  American  Banking 

Protection  of  Rediscounts 

It  is  worth  while  to  note  how  the  federal  reserve  bank  is 
affected  in  this  type  of  transaction.  In  the  first  place,  a 
member  bank  has  made  loans  to  customers  and  has  pre- 
sumably employed  all  the  usual  safeguards  that  are 
resorted  to  in  such  cases  to  make  sure  that  the  loan  is 
good.  The  federal  resei*\^e  bank  has,  in  addition  to  this 
general  investigation  made  by  the  member  bank,  the 
member  bank's  own  indorsement  of  warranty  that  the 
note  is  good.  In  addition,  as  elsewhere  seen,  the  federal 
reserve  bank  has  on  deposit  a  certain  amount  of  reserve 
funds  belonging  to  the  member  bank,  while  it  has,  of 
course,  the  capital  stock  contribution  made  by  the  member 
bank  in  order  to  become  a  member.  There  is  thus  a 
triple  additional  protection  against  loss  over  and  above 
what  the  ordinary  or  member  bank  has — namely,  the 
member  bank's  own  indorsement,  the  reserve,  and  the 
capital  contribution  of  the  member  bank,  which  may  be 
regarded  as  a  kind  of  insurance  margin  in  the  event  of 
failure,  inasmuch  as  the  reserve  bank  is  not  obliged  to 
return  to  a  member  bank  anything  except  the  balance, 
whatever  that  may  be,  due  it  after  all  liabilities  have  been 
liquidated. 

Precisely  because  the  protection  to  the  federal  reserve 
bank  is  thus  so  much  greater  than  to  the  member  bank, 
it  is  possible  for  the  federal  reserve  bank  to  make  its 
rate  low.  All  interest  rates  are  essentially  composed  of 
three  elements  (1)  the  "pure"  interest  on  money  or 
about  what  is  necessary  to  pay  in  order  to  induce  a  man 
who  possesses  capital  to  forego  the  use  of  it  for  a  time, 
although  assured  that  it  will  be  returned  at  a  specified 
date,  (2)  the  provision  for  expense  involved  in  the  mech- 
anism of  making  loans,  and  (3)  the  item  of  insurance 


Capital  and  Reserves  169 

against  risk.  It  is  probable  that  in  most  loans  currently 
made  the  last  is  far  greater  than  any  other.  The  federal 
reserve  bank,  therefore,  by  reducing  it  to  its  lowest 
terms,  makes  a  corresponding  cut  in  the  rate. 

Since  the  federal  reserve  banks  were  organized,  they 
have  been  able  to  make  rates  as  low  as  4  per  cent  per 
annum,  where  paper  matured  within  a  period  not  exceed- 
ing ninety  days.  Sixty-day  and  ninety-day  paper  have 
usually  borne  higher  rates  of  interest  than  thirty-day 
paper  and  the  question  may  be  asked  why  there  should 
be  this  discrimination  if  the  security  is  practically  as  good 
in  the  one  case  as  in  the  other.  The  answer  is  that  the 
security  cannot  be  called  so  good  in  the  case  of  the  longer 
maturities  as  in  that  of  the  shorter  date.  The  real  reason 
for  making  a  lower  rate  for  thirty-day  paper  is  that  the 
shorter  the  period  for  which  notes  run,  the  less  the  prob- 
ability that  the  funds  obtained  will  be  used  for  the  pur- 
pose of  financing  a  transaction  which  may  become  non- 
liquid.  As  has  already  been  seen,  the  less  the  degree  of 
liquidity,  the  less  is  the  probability  that  paper  will  be 
paid  at  maturity.  The  lack  of  ability  to  liquidate  does 
not  necessarily  mean  inability  to  make  ultimate  payment, 
but  it  does  mean  temporary  postponement. 

Making  Rates  Effective 

While  the  Federal  Reserve  Act  was  based  upon  the 
theory  that  the  fundamental  function  of  federal  reserve 
banks  was  to  discount  paper  for  their  member  banks, 
and  thereby  to  enable  these  institutions  to  liquidate,  the 
Act  also  made  provision  for  what  are  called  ' '  open  mar- 
ket operations. "  These  operations  were  of  several  kinds. 
The  banks  were  permitted  to  deal  in  the  securities  of  the 
United  States  Government  to  any  extent  they  saw  fit. 
They  were  also  authorized  to  purchase  and  sell  short- 


170  American  Banking 

term  obligations  of  states  and  mnnicipalities  running  not 
more  than  six  months.  Bankers'  acceptances  might  be 
bought  in  the  open  market,  and  finally  provision  was 
made  for  the  open  market  purchase  of  bills  of  exchange. 
It  is  thus  seen  that  if  federal  reserve  banks  were 
authorized  to  exercise  all  the  provisions  of  the  Act,  and 
chose  to  do  so,  they  would  have  a  very  wide  field  of 
acti\'ity  apart  from  member  banks.  Not  only  could  they 
deal  in  long-term  bonds  and  short-term  warrants  of 
municipalities  and  states,  but  they  might  invest  in  live 
commercial  paper  of  designated  varieties. 

At  first  sight  it  may  seem  as  if  the  extension  of  these 
powers  was  at  variance  with  the  idea  that  the  resources 
of  the  reserve  banks  were  intended  solely  for  the  benefit 
of  the  member  banks,  through  the  liquidation  of  paper  in 
which  their  fmids  might  have  been  invested.  There  are 
two  reasons  why  this  view  is  not  sound.  In  the  first 
place,  it  may  frequently  happen  that  member  banks  are 
not  in  need  of  discounts,  while  non-member  banks  would 
gladly  get  funds.  The  member  banks  may,  for  reasons 
of  their  own,  not  be  presenting  paper  to  federal  reserve 
banks  for  discount,  while  federal  reserve  banks  may  be 
largely  supplied  with  resources.  In  such  a  case  as  this, 
the  open  market  power  gives  the  federal  reserve  bank 
the  ability  to  relieve  a  non-member  bank  directly  should 
there  be  good  reason  for  so  doing,  and  at  the  same  time, 
has  the  opportunity  of  keeping  its  own  funds  invested  to 
some  extent,  thereby  earning  a  revenue  for  itself  at  times 
when  its  resources  would  otherwise  be  idle. 

The  second  reason  referred  to  above  is,  however,  more 
important.  It  is  that  the  federal  reserve  bank  owes  an 
obligation  not  only  to  its  member  banks  as  individual 
institutions,  but  also  to  its  member  banks  as  a  group  or 
community  of  institutions.    This  duty  is  that  of  prevent- 


Capital  and  Reserves  171 

ing  undue  fluctuations  in  rates  of  interest  and  maintain- 
ing, so  far  as  possible,  a  reasonable,  stable,  and  even  rate. 
There  may  easily  be  times  when  such  a  result  cannot  be 
obtained  simply  through  rediscount  operations.  In  order 
to  make  a  rediscount  rate  effective  in  the  market,  i.  e.,  to 
influence  the  commercial  rate  of  interest  and  to  insure 
that  that  rate  or  something  approximating  it  shall  be 
the  prevailing  rate  in  the  market,  it  may  be  necessary  at 
times  for  a  federal  reserve  bank,  or  any  other  institution 
exercising  the  same  powers,  to  become  an  active  factor 
in  the  open  market  and  to  buy  and  sell  at  the  rate  which 
it  has  itself  established. 

Clearly,  if  tlais.  function  were  not  thus  to  be  exercised, 
the  making  of  the  rate  of  discount  effective  would  be 
entirely  dependent  upon  the  extent  to  which  member 
banks  chose  to  obtain  rediscounts  from  federal  reserve 
banks.  With  the  power  on  the  part  of  federal  reserve 
banks  to  go  into  the  open  market,  the  control  of  the  pre- 
vailing interest  rate  is  always  in  the  hands  of  the  federal 
reserve  banks  if  they  have  a  substantial  amount  of  loan 
funds  at  their  disposal.  If  they  do  not  choose  to  employ 
these  loan  funds  in  open  market  operations,  it  is  because 
thej  do  not  consider  that  the  facts  in  the  case  warrant 
them  in  doing  so. 

Discount  v.  Purchase 

V 

One  other  point  needs  to  be  particularly  observed  in 
studying  the  functions  of  federal  reserve  banks  and  in 
differentiating  clearly  between  them.  It  will  have  been 
noted  that  when  funds  were  advanced  to  a  member  banl^, 
such  action  was  spoken  of  as  a  discount  or  rediscount, 
while  in  the  open  market  operations  the  placing  of  funds 
was  spoken  of  as  a  purchase  of  paper.  The  question  is 
often  asked,  how  a  purchase  of  paper  differs  from  a  dis- 


172  American  Banking 

count.  When  a  discount  is  made,  it  is  understood  that 
the  person  or  institution  obtaining  the  funds  leaves 
them  on  deposit  with  the  bank  which  extends  the  credit, 
i.  e.,  uses  them  simply  to  draw  upon  and  does  not  demand 
payment  in  actual  money.  If  he  needs  currency  he  takes 
it  in  the  notes  of  the  bank  which  extends  him  the  loan. 
Where  a  purchase  is  made  it  is  expected  to  be  paid  for 
in  actual  money,  thereby  reducing  the  reserves  of  the 
bank  which  makes  the  purchase,  in  a  corresponding 
degree.  The  effect  in  the  latter  case  is  to  limit  the  lend- 
ing power  of  the  institution  which  advances  the  funds, 
and  a  purchase  consequently  operates  to  restrict  the 
aggregate  power  of  the  bank  in  a  much  greater  degree 
than  does  a  discount,  in  which  the  funds  are  left  on 
deposit  ^and  are  simply  transferred  by  check. 

The  question  is  frequently  asked  whether  the  public 
obtains  any  benefit  from  the  rediscount  and  purchase 
operations  of  federal  reserve  banks,  in  view  of  the  fact 
that  it  cannot  discount  with  reserve  banks,  cannot  keep 
its  own  resources  with  them,  and  probably  only  in  a 
minority  of  cases  can  expect  to  deal  with  the  reserve 
banks  through  open  market  operations.  The  answer  to 
this  question  is  simply  that  whatever  lowers  the  rate  of 
interest  to  banks  in  general  in  a  country  where  banking- 
competition  exists,  helps  the  borrower  at  banks  in  a  like 
degree.  Any  five  persons  of  good  standing,  who  have 
twenty-five  thousand  dollars  capital,  can  charter  a 
national  bank,  and  this  insures  tolerably  keen  competi- 
tion between  banks.  The  benefits  of  the  reduced  rate 
of  rediscount  to  such  banks  are  more  or  less  speedily 
restricted  to  customers  of  the  banks.  Furthermore,  as 
already  seen,  the  object  of  the  federal  reserve  bank  is  to 
make  a  reasonable  and  stable  rate  of  interest,  and  this, 
if  secured,  is  of  decidedly  more  importance  to  the  busi- 


CapitcU  and  Reserves  173 

ness  and  commercial  interests  of  the  United  States  than 
is  the  mere  lowering  of  rates  of  interest. 

Peotecting  the  Notes 

In  what  has  been  said  about  the  reserve,  the  raising 
of  the  rate  of  discount,  the  provisions  of  the  National 
Bank  and  Federal  Reserve  Acts  as  to  reserve  and  the 
like,  constant  use  has  been  made  of  the  word  "deposits" 
for  the  purpose  of  indicating  the  demand  liabilities.  It 
may  have  seemed  from  this  as  if  the  bank  notes  issued 
by  the  institution  were  to  be  excluded  from  consideration. 
Such  is  not  the  case,  for  the  bank  notes  are  a  demand 
liability,  and  in  some  cases  are  likely  to  come  in  quite  as 
actively  for  cashing  as  do  the  deposit  credits.  Unless 
the  notes  are  protected  by  some  special  method,  there- 
fore, a  reserve  is  needed  behind  the  notes  just  as  much 
as  behind  the  deposit  liability,  and  in  some  cases  it  may 
be  even  more  necessary. 

In  some  of  the  large  banks  of  Europe,  extraordinarily 
high  reserves  of  cash  are  carried  behind  the  note  liabil- 
ities. This  is  because  the  notes  are  elastic  and  come  in 
for  frequent  liquidation,  and  inasmuch  as  they  constitute 
an  important  element  in  the  currency  system  it  is  of 
fundamental  importance  to  have  them  instantly  redeem- 
able in  any  amount  that  is  likely  to  be  desired. 

In  the  United  States,  under  the  National  Bank  Act, 
the  notes  of  national  banks  are  especially  protected  by 
United  States  bonds  and  by  a  5  per  cent  redemption  fund 
which  is  held  by  the  Treasury  of  the  United  States,  while 
federal  reserve  notes  are  protected  by  specially  segre- 
gated commercial  paper  and  a  large  specified  gold  reserve 
in  place  of  the  government  bonds  required  as  security 
under  the  National  Bank  Act.  The  framers  of  the 
National  Banking  Act,  believing  the  bond  deposits  witli 


174  American  Banking 

the  government  to  be  an  adequate  safeguard  for  the 
national  bank  notes,  devoted  most  of  their  safeguards, 
provisions  regarding  reserves  and  the  like,  to  the  deposit 
liabilities  of  the  banks. 

But  it  should  be  carefully  borne  in  mind  that,  where 
a  bank  has  the  choice  of  making  its  loans  either  through 
deposit  credits  or  through  note  issues,  the  issue  of  the 
notes  affects  the  reserve  in  the  same  way  as  does  the 
creation  of  deposit  credits  and  that  exactly  the  same 
precautions  are  requisite.  The  issue  of  notes,  then, 
should  stop,  just  as  should  the  granting  of  deposit  credits, 
whenever  the  reserve  reaches  the  danger  mark.  It  is 
unsafe  for  a  banker  to  rely  upon  the  continued  circula- 
tion of  his  notes  even  where  the  issue  is  inelastic  and 
where  therefore  the  notes  are  sluggish  in  being  presented 
for  redemption.  Since  the  note  liabilities  are  widely 
diffused,  being  usually  in  the  hands  of  a  great  many 
persons,  it  may  easily  happen  under  certain  conditions 
that  these  notes  Avill  come  in  even  more  rapidly  (if  gen- 
eral confidence  in  a  bank  has  been  assailed)  than  will 
checks  against  deposits  which  may  be  in  the  hands  of  men 
who  are  more  or  less  familiar  with  the  bank's  condition 
and  who  have  entire  confidence  in  it. 

'  *  GUAEANTEEING ' '   LIABILITIES 

It  has  been  explained  how  the  banks  of  the  national 
system  are  made,  in  a  sense,  jointly  responsible  for  the 
redemption  of  one  another's  notes  through  the  require- 
ment that  they  accept  such  notes  on  deposit.  It  has  also 
been  pointed  out  how  the  Canadian  banks  contribute  to 
a  joint  guaranty  fund  which  is  used  for  the  purpose  of 
redeeming  the  notes  of  any  banks  that  may  fail,  the  fund 
being-recouped  from  the  assets  of  the  insolvent  bank,  if 
possible.    The  success  of  such  systems  in  regard  to  notes 


Capital  and  Reserves  175 

has  led  to  a  demand  that  the  banks  be  compelled  to  guar- 
antee the  goodness  of  their  deposit  credits — that  is  to 
say,  be  compelled  jointly  to  establish  a  fund  out  of  which 
shall  be  paid  the  claims  of  depositors,  if  any,  who  are 
unable  to  collect  cash  from  a  bank  which  has  suspended 
or  failed. 

Such  a  scheme,  under  the  title  "Guarantee  of  bank 
•;  deposits ' '  has  been  a  feature  of  political  party  platforms 
in  the  past.  It  has  been  supported  on  the  ground  that 
an  examination  of  the  history  of  banlv  failures  under  the 
national  law  in  the  United  States  shows  that  a  very  small 
contribution  made  by  each  bank  in  the  form  of  a  per- 
centage on  its  outstanding  deposits  would  suffice  to  create 
a  fund  which  would  be  amply  sufficient  to  pay  all  losses 
that  might  be  incurred  by  depositors  in  insolvent  banks. 
It  has  been  suggested  that  the  establishment  of  such  a 
fund  would  render  the  banking  business  perfectly  secure 
and  would  operate  as  an  insurance  which  would  so  reas- 
sure depositors  that  "runs"  on  banks  would  become 
unknown,  while  in  the  event  of  a  bank  failure  depositors 
would  be  promptly  and  adequately  cared  for. 

There  are  several  objections  to  this  plan  which  may  be 
briefly  indicated  here.  The  plan  would  undoubtedly  make 
depositors  indifferent  about  the  institution  they  selected 
to  do  their  business.  This  would  place  a  premium  on  bad 
banking,  and  would  promote  the  growth  of  weak  insti- 
tutions, thereby  increasing  the  number  of  ultimate 
failures  and  the  losses  falling  on  the  guarantee  fund. 
More  important  than  this  is  the  fact  that  what  the  depos- 
itor wants  most  of  all  is  innnediate  payment  of  cash 
rather  than  assurance  of  the  ultimate  safety  of  his  depos- 
its, and  that  payment  in  cash  is  exactly  what  no  such  fund 
could  guarantee  since  in  the  event  of  a  general  bank  sus- 
pension (such  as  has  occurred  from  time  to  time),  the 


176  American  Banking 

fund  would  not  be  able  to  meet  all  the  demands  presented 
against  the  banks.  It  would  therefore  be  no  better  than 
the  security  afforded  by  the  banks  themselves. 

TEST  QUESTIONS 

1.  What  factors  are  taken  into  consideration  in  determining 
upon  the  amount  of  capital  for  a  bank? 

2.  What  is  the  purpose  of  a  bank's  surplus?     How  is  it 
created  ? 

3.  Wliat  are  the  provisions  of  the  National  Bank  Act  con- 
cerning surplus  ? 

4.  What  is  meant  by  undivided  profits?     How  does  the  ac- 
count arise? 

5.  What  is  meant  by  the  reserves  of  a  bank  ? 

6.  What  factoi-s  determine  the  amount  of  reserves  that  should 
be  carried  by  a  given  bank? 

7.  What  three  classes  of  reserve  cities  were  created  by  the 
National  Bank  Act  ? 

8.  What  was  the  chief  weakness  in  the  reserve  system  created 
l)y  that  Act? 

9.  What  changes  were  made  by  the  Federal  Reserve  Act  in  the 
reserve  requirements  of  national  banks? 

10.  Wliat  practical  methods  are  employed  by  bankers  for  re- 
storing depleted  reserves  ? 

11.  How  does  the  Federal  Reserve  system  aid  in  relieving  hard- 
pressed  banks? 

12.  How  does  a  rediscount  differ  from  a  purchase  of  com- 
mercial paper? 

13.  In  what  ways  does  the  public  benefit  directly  from  the  dis- 
count privilege  of  banks? 


CHAPTER  XII 

THE  BANK  STATEMENT 

A  bank  statement  is  a  condensed  report  of  the  solvency 
facts  of  a  bank.  It  gives  on  the  one  side  a  summary  of 
the  resources,  and  on  the  other  a  summary  of  the  lia- 
bilities. As  a  rule,  these  reports  are  not  only  made  at 
stated  intervals  to  the  Board  of  Directors  and  stockhold- 
ers of  a  bank,  but  also  published,  either  voluntarily  or 
under  statutory  provisions,  for  the  benefit  of  the  banking 
public.  Many  banks,  furthermore,  make  it  a  practice  to 
mail  a  copy  of  such  statements  to  their  customers  and 
friends.  An  understanding  of  the  several  items  that 
appear  in  such  a  statement  ^vill  not  only  make  such 
reports  intelhgible  to  the  reader  and  user  of  banking 
services,  but  afford  also  a  clearer  understanding  of  the 
operations  of  a  bank. 

The  true  character  of  the  bank  statement  may  be 
grasped  most  easily  if  we  trace  the  several  items  that 
enter  into  such  a  report  from  their  beginning  and  follow 
them  through  all  the  operations  of  banking.  A  simple 
illustration  will  be  used.  Imagine  a  bank  chartered,  its 
officers  elected,  its  employees  chosen,  and  the  institution 
practically  ready  to  do  business  with  its  capital  in  hand 
in  cash.  The  first  thing  necessary  before  opening  for 
actual  transactions  is  the  purchase  of  a  suitable  banking 
house,  with  vault,  fixtures,  etc.  This  involves  a  con- 
siderable expense  and  must  be  paid  for  at  once  out  of 
the  capital. 

177 


178  American  Banking 

Supposing  that  such  a  bank  has  a  capital  of  $100,000 
paid  up  in  gold  coin  or  gold  certificates,  supposing  fur- 
ther that  as  a  preliminary  to  doing  business  it  has 
invested  $5,000  in  a  banking  establishment,  what  Avill  be 
the  condition  of  this  institution  upon  the  morning  when 
its  doors  are  first  thrown  open?  Its  assets  will  consist 
of  two  distinct  elements — the  coin  on  hand  and  the  bank- 
ing establishment.  Its  liabilities  will  consist  of  the  debt 
it  owes  to  its  stockholders  who  have  contributed  the  cap- 
ital \vith  which  to  start.  Capital  is  always  a  liability 
since  it  constitutes  a  sum  which  must  be  paid  back  to  the 
stockholders,  in  whole  and  with  a  profit  if  the  bank  is 
successful,  in  part  if  the  bank  is  unsuccessful  and  loses. 
At  the  beginning  of  business,  then,  the  bank  of  our 
hypothesis  will  present  the  following  appearance,  if  a 
statement  of  resources  and  liabilities  be  made  up : 

Eesources  Li^vbilities 

Gold    $  95,000      Capital    $100,000 

Banking    establishment 5,000 


Total $100,000  Total $100,000 

The  bank  is  now  ready  to  begin  actual  dealings  with  the 
public.  Suppose  that  depositors  come  in,  with  gold  or 
its  equivalent  in  their  possession,  and  leave  such  gold  to 
the  extent  of  $10,000  with  the  bank.  This  will  increase 
its  gold  or  specie  by  $10,000  but  it  will  also  owe  $10,000 
to  depositors.    Its  statement  will  then  stand  as  f oUows : 

Eesoueces  Liabilities 

Gold    $105,000      Capital  $100,000 

Banking  establishment 5,000      Deposits   10,000 


Total $110,000  Total $110,000 

Suppose  now  that  five  persons,   one   after   another, 
apply  for  loans  to  an  aggregate  of  $5,000  while  five  others 


Bank  Statement  179 

present,  for  discounting,  notes  of  outsiders  with  whom 
they  have  had  dealings  to  the  amount  of  $5,000  additional 
Suppose  that  these  loans  are  approved  by  the  bank.  The 
question  then  arises :  In  what  form  will  the  loans  be 
made?  As  seen  at  a  former  point,  they  must  be  made 
either  by  the  actual  payment  of  coin  or  currency,  by  the 
granting  of  a  deposit  credit,  or  by  the  issue  of  bank 
notes.  It  has  also  been  seen  that  in  practice  the  latter 
two  are  the  ways  in  which  loans  are  made.  We  may 
suppose  therefore  that  the  first  five  customers  took  their 
loans  in  bank  notes  and  that  the  second  five  took  them 
in  deposit  credits.  The  statement  of  the  bank's  condi- 
tion will  then  look  like  this : 

Kesoukces  Liabilities 

Gold    $105,000  Capital  $100,000 

Banking  establishment 5,000  Deposits 15,000 

Loans  and  discounts 10,000  Notes 5,000 


Total $120,000  Total $120,000 

It  may  be  supposed,  however,  that  the  holders  of  the 
notes  pay  them  out  immediately  to  others  and  that  these 
others  for  reasons  of  their  own  desire  in  some  cases  to 
get  the  coin.  Suppose  that  $2,000  of  the  notes  are  pre- 
sented for  cashing.  It  may  also  be  assumed  that  the 
depositors  will  transfer  their  funds,  in  part  at  least,  to 
others  by  means  of  checks,  and  that  these  checks  will  be 
deposited  with  other  banks  and  will  be  presented  by  them 
for  cashing.  Suppose  that  the  amount  of  checks  thus 
presented  is  $3,000,  then  the  statement  of  the  bank  will 
present  the  following  appearance: 

Resources  Liabilities 

Gold $100,000  Capital  $100,000 

Banking  establishment 5,000  Deposits 12,000 

Loans  and  discounts 10,000  Notes 3,000 


Total $115,000  Total $115,000 


180  American  Banking 

This  process  may  go  on  indefinitely,  with  deposits  in 
coin  or  currency,  and  loans  made  by  granting  deposit 
credits  or  by  issuing  notes. 

At  the  end  of  the  year  the  bank  may  find  that  as  a 
result  of  its  operations  it  has  coming  to  it,  say,  $10,000 
in  interest.  How  will  this  amount  appear  on  its  books? 
The  directors  of  the  institution  ma}^  decide  to  declare  a 
dividend  of  2  per  cent  on  the  capital  stock  which  will 
require  $2,000,  to  maintain  $5,000  as  a  permanent  addi- 
tion to  their  capital  which  is  ordinarily  termed  a  *' sur- 
plus," and  to  carry  the  balance  as  ''undivided  profits." 
Supposing,  for  the  sake  of  convenience,  that  the  interest 
($10,000)  due  the  bank  has  been  handed  to  it  in  coin,  the 
statement  would  then  look  like  this : 

Resources  Liabilities 

Gold $110,000      Capital  $100,000 

Banking  establishment 5,000      Deposits 12,000 

Loans  and  discounts 10,000      Notes    3,000 

Surplus  5,000 

Undivided  profits 3,000 

Dividend    2,000 


Total $125,000  Total $125,000 

Immediately  upon  being  notified  of  the  declaration  of 
a  dividend,  the  stockliolders  would  either  draw  out  the 
dividend  in  cash  or  else  have  it  credited  to  their  accounts. 
Perhaps  it  might  be  credited  to  start  with,  without  going 
through  the  intermediate  operation  already  traced,  but 
the  result  would  be  the  same  in  either  case.  If  the  divi- 
dend were  transferred  to  the  individual  depositors' 
accounts,  this  would  increase  the  item  of  ''deposits"  and 
would  wipe  out  the  dividend  item. 

The  bank  would  also  find  that  it  had  some  expenses  to 
pay.  If  we  assume  for  the  sake  of  convenience  that  its 
expenses  were  not  paid  until  the  end  of  the  year  instead 


Bank  Statement  181 

of  being  paid  monthly,  it  will  simplify  matters.  Suppose 
that  for  the  year  its  total  expenses  are  $2,000,  how  should 
these  appear  in  the  statement!  Evidently,  if  they  are 
paid  out  in  cash,  they  will  reduce  the  cash  resources  of 
the  institution.  But  the  bank  will  have  to  make  a  show- 
ing to  its  stockholders  that  would  indicate  where  the 
money  has  gone.  Now,  if  we  suppose  that  one-half  of 
the  stockholders  draw  out  their  share  ($1,000)  of  the 
dividend  declared,  while  the  other  one-half  have  the  divi- 
dend transferred  to  their  individual  accounts,  and  if  we 
suppose  that  the  bank  disburses  $2,500  in  cash  to  pay 
its  expenses,  the  situation  will  look  like  this : 

Eesoueces  Liabilities 

Gold    $106,500      Capital   $100,000 

Banking  establishment 5,000      Deposits 13,000 

Loans  and  expenses 10,000      Notes    3,000 

Expenses    2,500      Surplus    5,000 

Undivided  profits    3,000 


Total $124,000  Total $124,000 

It  may  be  that  the  bank  feels  that  it  is  unwise  to  keep 
so  large  a  quantity  of  gold  on  hand  and  consequently 
determines  to  put  $50,000  in  gold  into  the  purchase  of 
bonds.  It  may  not  be  possible  to  get  these  bonds  at  a 
premium  and  so  it  decides  to  buy  $40,000  par  value  of 
bonds  at  125  which  makes  an  outlay  of  $50,000  in  cash. 
This  will  make  the  following  change  in  its  statement : 

Eesources  Liabilittes 

Gold    $  56,500  Capital  $100,000 

Banking    establishment ....  5,000  Deposits   13,000 

Loans   and    discounts 10,000  Notes    3,000 

Expenses    2,500  Surplus 5,000 

Bonds  40,000  Undivided  profits    3,000 

Premiums  on  bonds 10,000 


Total    $124,000  Total    $124,000 


182  American  Banking 

The  foregoing  statement  shows  most  of  the  primary 
operations  of  banking.  The  essential  nature  of  the  dif- 
ferent items  has  been  explained.  The  relative  size  of 
the  items  will  vary  with  the  business  transacted.  In 
fact,  the  items  of  "Discount  and  Loans"  and  ''Deposits" 
in  the  foregoing  statement  are  disproportionately  small 
for  a  going  banking  concern.  We  have  recorded  only 
the  first  simple  transactions.  In  actual  practice  these 
two  items  involve  the  largest  single  sum  in  the  resources 
and  liabilities  of  a  bank  statement. 

Bank  statements  are  not  yet  standardized  as  to  classi- 
fication of  items,  number  of  items,  or  their  form  of  state- 
ment, though  all  bank  statements  tend  to  conform  to  a 
uniform  type.  From  the  very  nature  of  banking  opera- 
tions no  stereotyped  form  of  statement  can  be  used 
because  the  functions  and  operations  of  banks  differ — 
notably  so  with  the  four  classes  of  banks  known  as  sav- 
ings banks,  trust  companies,  state  banks,  and  national 
banks.  Banking  laws  vary  as  to  the  items  to  be  included 
in  such  a  statement  and  as  to  how  each  item  is  to  be 
stated  or  subdivided. 

A  most  common  and  essential  item  may  be  indicated 
in  a  few  actual  classifications  of  resources  and  liabilities. 

A  certain  state  bank  makes  the  following  very  con- 
densed report: 

Eesotjrces  Liabilities 

Loans  and  discounts..  .$1,150,493.04  Capital  stock    $  200,000.00 

Overdrafts   110.70  Surplus     50,000.00 

Stocks  and  bonds 111,316.74  Undivided  profits 23,008.03 

Building     69,374.15  Reserved  for  taxes  and 

Cash     and     sight     ex-                                  interest 3,247.71 

change    341,615.30  Deposits   1,396,654.19 


Total    $1,672,909.93  Total    $1,672,909.93 


Bank  Statement  183 

The  report  of  one  of  our  largest  national  banks  follows 
herewith : 

Eesources 

Loans  and  discounts   $123,581,233.89 

Overdrafts    3,689.58 

U.  S.  bonds  to  secure  circulation    8,640,000.00 

U.  S.  bonds  to  secure    deposits    250,000.00 

Other  stocks,  bonds  and  mortgages   15,719,128.41 

Eeal  estate,  furniture  and  fixtures 13,847.00 

Premiums  paid   63,062.50 

Due  from  other  national  banks   18,138,682.35 

Due  from  state  banks   and   bankers 5,862,007.47 

Exchange  for  clearing  house   5,709,024.08 

Bills  of  other  banks   450,560.00 

Cash  items,  nickels,  etc 140,970.87 

Specie   20,298,507.10 

Legal  tender  notes    15,357,940.00 

Redemption  fund  432,000.00 

Due  from  U.  S.  treasurer 640,000.00 

Total    $215,300,653.25 

Liabilities 

Capital  stock  paid  in   $  21,500,000.00 

Surplus   fund    8,500,000.00 

Undivided    profits    1,594,958.31 

National  bank  notes  outstanding   8,550,100.00 

Individual  deposits  subject  to  check 74,087,245.87 

Demand  certificates  of  deposit   1,165,603.22 

Certified  checks  783,010.48 

Cashier's  check  outstanding 776,776.21 

Due  to  other  national  banks 60,259,316.25 

Due  to  state  banks  and  bankers   37,248,655.29 

Dividends  unpaid   1,134.00 

United  States  deposits   408,853.62 

Eeserve  for  taxes    425,000.00 

Total    $215,300,653.25 

This  report  also  conforms  in  general  with  our  former 
illustration.  Some  of  the  special  items  here  listed  are 
such  as  arise  out  of  the  peculiar  relations  of  national 
banks  to  the  federal  government  and  from  the  note-issue 


184  American  Banking 

functions  of  these  banks.  The  discussions  of  these  ques- 
tions contained  in  tliis  book  should  make  clear  the  reason 
for  the  existence  of  these  items  in  the  bank  report. 

The  item  of  overdrafts  we  have  not  yet  considered.  It 
arises  when  a  customer  overdraws  his  account,  some- 
thing which  is  frequent  in  business  operations,  but 
which  should  be  discouraged  by  every  banker.  It  is 
simply  an  adchtional  courtesy  or  credit  accommodation 
which  the  bank  may  grant  or  refuse  a  depositor.  Such 
overdrafts  may  be  secured  or  unsecured.  They  may 
sometimes  be  considered  an  asset  equally  as  sound  as 
loans,  if  selected  with  the  same  care. 

It  will  be  apparent  at  once  that  from  a  solvency  stand- 
point two  banks  with  identical  reports  may  be  utterly 
dissimilar  in  solvency.  A  good  shomng  on  a  balance 
sheet  may  be  made  by  a  bank  the  very  day  before  it  is 
compelled  to  close  its  doors.  These  discrepancies  in  bank 
reports  must  be  looked  for  in  the  individual  items,  and  by 
far  the  most  important  item  is  that  of  Loans  and  Dis- 
counts. These  often  contain  far  less  actual  assets  than 
the  figures  call  for.  It  is  the  purpose  and  function  of  a 
good  system  of  bank  inspection  to  examine  behind  the 
figures  so  as  to  make  certain  that  a  bank  balance  sheet 
represents  banking  facts  rather  than  fiction. 

TEST  QUESTIONS 

1.  What  is  meant  by  a  bank  statement? 

2.  Why  is  capital  considered  a  liability  ? 

3.  Why  are  surplus  and  undivided  profits  listed  as  liabilities  ? 

4.  Why  are  expenses  listed  as  a  resource  ? 

5.  Of  what  is  the  loans  and  discount  item  composed?  the  de- 
posits item? 

6.  What  are  the  two  largest  items  in  a  bank  statement? 

7.  Why  is  a  bank  statement  not  necessarily  a  safe  index  to  the 
solvency  of  a  bank  ? 


CHAPTER  XIII 

GOVERNMENT   AND    BANKING 

What  has  been  said  of  the  nature  of  banking  thus  far 
shows  that  the  bank  stands  in  a  peculiar  position  with 
reference  to  general  business.  Its  responsibilities  are 
extensive  and  heavy  and  a  misstep  or  blunder  at  any 
point  inevitably  results  in  a  widely  reflected  suffering  on 
the  part  of  the  business  community.  This  has  been  grad- 
ually recognized  by  the  governments  of  the  world  and, 
practically  everywhere,  they  have  assumed  a  certain 
amount  of  control  of  the  banking  business. 

This  control  varies  greatly  in  intensity,  partly  in 
accordance  with  the  exact  functions  performed  by  the 
bank  and  the  extent  to  which  they  are  public  in  their 
nature,  but  partly  according  to  the  general  idea  enter- 
tained by  the  people  of  a  given  nation  with  respect  to  the 
proper  relationship  between  the  government  and  the 
individual  business  men.  It  has  been  recognized  also 
that  a  different  degree  of  control,  or  at  all  events  a 
different  method  of  applying  such  control,  is  to  be 
employed  according  to  the  particular  group  or  class  to 
which  a  given  banking  institution  belongs.  This  makes 
the  system  of  government  oversight  in  vogue  in  the  vari- 
ous countries,  or  even  in  any  one  country,  exceedingly 
complex,  and  renders  it  highly  desirable  to  note  the  gen- 
eral principles  upon  which  government  control  is  applied 
before  proceeding  to  a  detailed  study  of  legal  require- 
ments. 

185 


186  American  Banking 

Pkinciples  of  Conteol 

In  the  abstract  it  is  not  hard  to  state  the  general  prin- 
ciples of  control.  The  government  seeks  first  of  all  to 
assure  absolute  soundness  and  solvency  in  banking.  It 
wants  to  protect  the  stockholder  and  the  creditor  to 
such  an  extent  that  they  may  feel  perfectly  sure  of  the 
safety  of  their  claims  against  the  bank.  Besides  this, 
it  endeavors  to  assure  the  liquidity  or  redeemability  on 
sight  of  every  demand  obligation  against  the  bank.  It 
is  hard  to  say  which  of  these  demands  is  the  more  funda- 
mental. Both  represent  requirements  that  are  absolutely 
indispensable  and  which  it  is  the  object  of  every  govern- 
ment that  undertakes  the  supervision  of  banking  to 
maintain. 

In  seeking  to  attain  these  ends,  governments  follow 
three  general  lines  of  action.  In  the  first  place,  they 
usually  specify  the  kinds  and  classes  of  loans  in  which 
banks  may  engage  and  the  character  of  the  security  that 
shall  be  accepted  for  such  loans.  In  the  second  place, 
they  endeavor  to  enforce  certain  requirements  regarding 
-  the  amount  of  coin  on  hand  and  the  protection  of  the 
liabilities  that  are  payable  at  sight.  Thirdly,  they  seek 
to  hold  bankers  up  to  a  high  standard  of  work  and  at  the 
same  time  to  make  sure  that  the  institutions  are  entirely 
free  from  any  taint  of  dishonesty,  by  regular  inspection 
and  examination  carried  on  through  the  agency  of  gov- 
ernment overseers  or  examiners.  They  also  require 
regular  reports  from  the  banks  certifying  to  their  con- 
dition. Where  a  bank  is  vested  with  a  monopoly  privilege 
of  some  kind  or  exercises  in  some  peculiar  way  a  public* 
or  quasi-public  function,  the  government  may  go  so  far 
as  to  insist  that  it  shall  be  represented  on  the  board  of 
directors  and  shall  thus  have  a  voice  in  the  active  man- 


Government  and  Banking  187 

agement  of  the  concern.    This  is  the  case  in  most  of  the 
great  European  banks. 

Regulating  Loans 

The  most  fundamental  type  of  regulation  in  which  a 
government  can  engage  is  the  effort  to  exercise  control 
over  the  loans  and  operations  of  the  bank.  This  is  an 
extremely  difficult  thing  to  do  with  success,  but  there  are 
certain  lines  along  which  it  can  properly  and  beneficially 
be  attempted.  Under  the  National  Bank  Act,  three 
classes  of  regulations  applying  to  loans  may  be  noted: 
(1)  The  National  Bank  Act  prohibits  certain  classes  of 
loans  absolutely;  (2)  It  limits  the  amount  of  certain 
classes  of  loans  and  the  persons  to  whom  they  may  be 
made;  (3)  It  attempts  within  limits  to  control  the  kind 
of  security  upon  which  business  may  be  done. 

These  limitations  are  not  always  lived  up  to,  but  the 
mere  imposing  of  them  is  a  beneficial  thing,  and  the  gov- 
ernment is  constantly  seeking  to  bring  about  a  better  and 
better  recognition  and  observance  of  the  regulations  it 
has  laid  down.  A  good  deal  of  progress  has  been  made 
in  this  direction  within  recent  years,  and  the  effect  of  it 
has  been  to  brace  up  other  banks  organized  under  state 
laws  and  to  bring  them  by  the  force  of  competition  into 
a  position  that  will  compare  favorably  with  that  of  the 
national  banks. 

Prohibited  Loans 

National  banks  are  forbidden  to  make  any  loan  or 
discount  on  the  security  of  the  shares  of  its  own  capital 
stock,  nor  may  they  purchase  or  hold  any  such  shares 
unless  the  operation  is  necessary  to  prevent  loss  upon 
a  debt  previously  contracted  in  good  faith.  In  the  same 
way,  the  bank,  except  when  authorized  by  the  Federal 


188  American  Banking 

Reserve  Act,  is  not  allowed  to  make  loans  upon  real  estate 
security  and  may  only  hold  real  estate  for  its  own  accom- 
modation, or,  in  case  it  has  purchased  real  estate  under 
judgments,  etc.,  or  obtained  it  in  satisfaction  of  debts 
previously  contracted,  in  which  event  it  shall  get  rid  of 
the  real  estate  within  five  years. 

There  are  certain  other  classes  of  prohibited  loans 
which  grow  out  of  various  requirements  of  the  National 
Bank  Act,  but  enough  has  been  said  to  indicate  the 
direction  that  these  prohibitions  take.  It  is  the  object 
of  the  law  to  prevent  the  acceptance  of  improper  security 
or  security  which,  although  sound,  is  not  liquid — that  is 
to  say  cannot  be  realized  upon  promptly.  The  import- 
ance of  regulating  loans  on  real  estate  has  been  especially 
well  recognized  within  recent  years,  and  the  requirement 
of  the  National  Banking  Act  in  this  regard  has  been 
imitated  by  other  banking  laws. 

Restriction  on  Loans 

Just  as  the  National  Bank  Act  prohibits  certain  classes 
of  loans,  it  endeavors  to  limit  the  amount  of  certain 
others.  Thus  the  loans  made  to  any  single  person,  com- 
pany, corporation,  or  firm,  for  money  borrowed,  including 
in  the  liabilities  of  a  company  or  firm  the  liabilities  of 
the  several  members  thereof,  shall  at  no  time  exceed  one- 
tenth  part  of  the  capital  stock  and  surplus  of  such 
association  actually  paid  in,  or  an  amount  greater  than 
thirty  per  cent  of  the  capital  in  the  aggregate.  So  also 
the  "bank  is  prohibited  from  being  indebted  to  an  amount 
exceeding  its  capital,  except  as  a  result  of  the  issue  of 
notes,  the  creation  of  deposits,  the  acceptance  of  bills  of 
exchange,  and  the  liabilities  to  the  stockholders  for  divi- 
dends and  reserved  profits. 

Of  course  the  object  of  these  and  other  provisions  of 


Government  and  Banking  189 

the  same  sort  is  to  prevent  the  funds  of  the  bank  from 
being  tied  up  with  the  affairs  of  any  one  man  or  firm  too 
exclusively,  and  to  prevent  the  bank  from  inflating  its 
liabilities  in  a  dangerous  manner.  It  is  recognized  that 
when  a  bank's  loans  are  widely  distributed  throughout 
a  community,  the  bank  is  as  sound  probably  as  the  sound- 
est section  of  the  conmiunity,  whereas,  if  it  is  closely 
entangled  with  a  few  concerns,  it  has  to  stand  or  fall 
with  them. 

So  also  the  question  of  loans  to  officers  and  directors 
must  be  carefully  controlled  in  order  to  prevent  insti- 
tutions from  advancing  their  funds  and  those  of  others 
that  have  been  deposited  Avith  them  to  the  persons  who 
are  in  control  of  the  bank  at  the  time.  This,  however, 
is  a  matter  which  can  be  best  managed  through  the 
administrative  supervision  of  the  government  officer  who 
makes  periodical  inspections  of  the  bank  and  gives  advice 
as  to  the  directions  along  which  it  should  seek  to  control 
its  business. 

Requirements  as  to  Reserve,  etc. 

Behind  the  general  requirements  of  the  national  bank 
law  with  reference  to  the  amount  of  loans  and  discounts 
and  the  persons  to  whom  they  may  be  made,  is  the  list 
of  requirements  with  respect  to  the  maintenance  of  the 
bank  in  an  immediately  liquid  condition.  The  most  fun- 
damental of  these  is  the  provision  regarding  reserve, 
already  sufficiently  discussed.  In  the  same  class  may  be 
put  the  provisions  regarding  the  special  protection  of 
notes,  already  outlined.  To  observe  these  two  classes 
of  restrictions  may  at  times  quite  rigidly  limit  the  scope 
of  the  bank's  operations,  and  may  therefore  prevent  it 
from  engaging  in  business  that  it  would  otherwise  be 
willing  to  take  on. 


190  American  Banking 

The  effect  of  this  is  to  lead  the  bank  usually  to  reject 
certain  classes  of  business,  because,  other  things  equal, 
the  bank  desires  to  keep  in  the  most  solvent  possible 
condition,  as  well  as  in  the  most  profitable  position,  and 
this  is  practicable  only  through  the  limitation  of  its 
business  to  legitimate  commercial  loans.  Thus,  where 
the  banking  capital  of  the  community  is  not  excessive,  the 
tendency  is  for  the  commercial  banks  of  that  community 
to  hold  themselves  down  rather  rigidly  to  straight  com- 
mercial paper  operations  and  thus  to  keep  in  a  tolerably 
liquid  condition.  The  danger  comes  when  a  bank  has 
been  tempted  to  make  large  loans  upon  a  given  kind  of 
business  paper  which  later  becomes  hard  to  realize  on, 
owing  to  the  development  of  a  commercial  situation 
unfavorable  to  the  business  upon  which  this  particular 
kind  of  paper  has  been  built  up.  This  is  a  matter  that 
cannot  be  controlled  by  law  and  can  be  guarded  against 
only  in  the  way  just  suggested  and  in  other  ways  of  the 
same  kind,  all  depending  upon  the  maintenance  of  such 
requirements  as  to  reserve,  classes  of  paper,  etc.,  as 
judgment  may  seem  to  dictate. 

Oversight  of  Loans 

While  the  internal  organization  of  the  tj^^ical  federal 
reserve  bank  is  thus  in  its  outline  substantially  similar 
to  that  of  the  commercial  bank,  there  are  certain  phases 
of  the  work  of  the  reserve  banks  that  differentiate  it  quite 
sharply  from  the  work  of  commercial  institutions.  In  the 
ordinary  bank,  a  great  deal  of  the  hazard  or  risk  result- 
ing from  the  operations  of  the  institution  is  due  to 
uncertainty  as  to  the  goodness  of  the  loans  that  are  made 
and  doubt  as  to  the  character  of  the  paper.  The  shrewd- 
ness and  acumen  of  the  ordinary  bank  president  and  his 
immediate  aides,  is  exerted  in  determining  whether  given 


Government  and  Banking  191 

individuals  who  want  to  borrow  are  ''good"  and  when 
satisfied  that  they  are  ''good,"  in  ascertaining  whether 
they  will  be  able  to  pay  at  the  time  they  say  they  will,  or 
whether  they  will  have  to  be  ' '  carried ' '  beyond  that  date, 
by  extending .  their  loans,  in  order  to  enable  them  to 
gather  their  strength  and  get  in  the  cash  needed  to  pay 
off  the  bank. 

The  federal  reserve  bank  must  meet  a  problem  which 
in  this  respect  is  different  from  that  presented  to  the 
ordinary  bank.  It  discounts  no  paper  without  the 
indorsement  of  a  member  bank,  which  means  that  the 
paper  thus  offered  for  rediscount  by  the  federal  reserve 
bank  has  passed  under  the  scrutiny  of  the  officers  of  the 
member  bank  and  is  indorsed  or  guaranteed  by  them. 
This  means  that  if  the  maker  of  the  paper  does  not  pay 
at  maturity,  the  member  bank  must  make  good  the  short- 
age. The  commercial  side  of  the  bank's  work  is  thus 
considerably  simplified.  It  can  delegate  to  the  member 
bank  a  large  part  of  the  task,  passing  upon  the  value  of 
the  signatures  of  the  borrowers,  the  examination  of  their 
statements,  their  business  condition,  and  the  like.  Only 
in  those  cases  where  a  borrower  has  so  large  a  volume 
of  paper  outstanding  in  the  hands  of  so  many  different 
banks  as  to  make  the  problem  of  his  responsibility 
greater  than  can  be  dealt  with  by  any  individual  bank 
or  group  of  banks,  does  this  question  of  testing  his  lia- 
bility become  really  a  problem  for  the  federal  reserve 
bank  itself  to  deal  with. 

In  another  way,  however,  the  federal  reserve  bank  has 
a  highly  special  function  which  is  not  performed  by  the 
commercial  bank.  This  is  the  duty  of  testing  the  valid- 
ity of  the  total  volume  of  bank  credit  and  of  ascertaining 
whether  in  the  aggregate  the  banks  of  the  community  are 
going  too  far  in  extending  their  loans  to  their  customers. 


192  American  Banking 

Such  an  over-extension  may  make  itself  evident  in  either 
of  two  ways — it  may  be  seen  in  the  presentation  to  the 
Federal  Reserve  Board  of  a  great  deal  of  paper  originat- 
ing with  the  same  makers  which  has  found  its  way  into  the 
portfolios  of  various  banks  and  has  by  them  been  offered 
for  rediscount  in  the  ordinary  course  of  business,  or 
it  may  be  seen  in  the  fact  that  given  member  banks, 
although  not  necessarily  becoming  burdened  with  too 
great  a  volume  of  paper  coming  from  an  identical  source, 
are  obtaining  from  federal  reserve  banks  accommoda- 
tions which  constitute  too  large  a  proportion  of  their 
capital,  i.  e.,  which  involve  a  contingent  liability  bearing 
too  great  a  proportion  to  such  capital.  To  reach  this 
determination  accurately  requires  a  general  survey  of 
the  banking  field,  knowledge  of  the  general  business  con- 
ditions to  which  the  various  member  banks  are  subject, 
and  broad  analysis  of  the  bank  credit  situation  generally. 
This  is  the  primary  ''central  banking"  function — the 
determination  whether,  in  a  given  district  or  country, 
bank  credit  as  a  whole  is  being  too  largely  extended  as 
compared  with  the  available  means  for  liquidation  with- 
out an  undue  amount  of  renewal. 

The  commercial  bank  does  not  concern  itself  primarily 
with  questions  of  this  class,  but  is  chiefly  interested  in 
its  own  profits  and  is  disposed  to  go  as  far  as  it  feels  that 
it  can  in  making  loans,  without  bringing  its  own  solvency 
into  jeopardy.  No  doubt  there  are  large  and  public 
spirited  institutions,  more  or  less  international  in  the 
scope  of  their  operations,  which  take  a  broader  view  of 
their  relation  to  the  community  than  this,  but  it  is  not 
unfair  to  say  that  the  bulk  of  the  banking  community 
hardly  feels  called  upon  to  look  beyond  the  immediate 
welfare  and  solvency  of  the  institutions  in  which  they  are 
immediately  interested.    The  federal  reserve  bank  must, 


Government  and  Banking  193 

however,  take  the  broader  view  since  the  primary  pur- 
pose of  its  organization  is  that  of  suppljdng  the  elements 
of  co-operation  and  conservation  of  resources. 

Inspection  and  Examination 

It  is  probable  that,  with  the  large  number  of  banks 
competing  actively  for  business,  it  would  be  practically 
out  of  the  question  to  expect  a  very  rigid  adherence  to 
the  requirements  of  law  if  this  were  left  entirely  to  the 
banks  themselves.  Bank  managers  might,  and  probably 
would,  recognize  the  abstract  desirability  of  living  up 
to  the  requirements  of  the  law,  but  they  would  be  tempted 
to  get  away  from  it  in  connection  with  some  particularly 
alluring  operation  and  thereafter  the  habit  of  doing  so 
would  in  many  cases  become  fixed.  Recognizing  this,  the 
national  banking  law  has  provided  for  a  special  corps  of 
examiners  who  are  organized  under  an  officer  called  the 
comptroller  of  the  currency  whose  office  is  in  the  Treas- 
ury Department  at  Washington. 

Although  this  officer  is  called  the  comptroller  of  the 
currency  his  operations  do  not  relate  to  the  ''currency" 
exclusively  but  are  largely  centered  upon  the  supervision 
of  the  loan  operations  of  the  banks.  He  has  about  100 
examiners  under  his  direction  and  these  men  are  con- 
stantly going  from  bank  to  bank  along  specified  routes 
which  are  mapped  out  for  them  in  the  central  office, 
making  a  more  or  less  careful  examination  of  the  affairs 
of  each  institution  and  then  reporting  in  full  to  the 
comptroller  at  Washington,  he  being  supposed  to  take 
up  and  study  the  reports  Avhich  are  thus  turned  in  and 
w4iere  necessary  to  call  to  the  attention  of  a  given  bank 
any  particulars  in  which  its  methods  ought  to  be 
improved. 


194  American  Banking 

Work  of  Examinees 

The  examiner,  when  he  visits  a  bank,  is  supposed  to 
examine  its  books,  making  sure  that  they  are  being  cor- 
rectly kept  and  that  they  truly  exhibit  the  conditions  in 
the  institution.  The  examiner  looks  through  the  cash 
in  the  vaults  in  order  to  see  that  it  is  as  represented  and 
also  the  securities  that  are  held  as  investments  or  as 
collateral.  He  pays  particular  attention  to  the  char- 
acter and  distribution  of  the  loans  and  notes,  looking  not 
only  for  instances  where  the  provisions  of  the  national 
act  are  being  violated  but  for  instances  w^here  the  bank 
without  violating  any  law  is  running  into  what  he  con- 
siders a  dangerous  position  which  may  imperil  its  funds. 
After  getting  the  data  for  a  report,  the  examiner  fur- 
nishes the  comptroller  Avith  a  statement  of  prescribed 
character  covering  certain  data  that  are  wanted  in  the 
case  of  every  bank,  and  then  he  makes  additional  remarks 
such  as  have  occurred  to  him  in  the  course  of  his  observa- 
tions. 

Under  regulations  recently  established,  the  force  of 
bank  examiners  has  been  separately  organized  for  each 
federal  reserve  district.  In  each  district  there  is  a  chief 
examiner,  and  it  has  been  customary  to  hold  periodical 
meetings  at  which  to  compare  notes  and  talk  over  the 
situation.  The  chief  examiner  keeps  the  comptroller 
closely  advised  with  reference  to  the  general  banking 
outlook  in  the  district  of  which  he  is  in  charge.  The 
comptroller  himself  may  communicate  to  the  examiners 
of  a  given  district  such  information  regarding  affairs  in 
that  district  or  other  districts  as  he  may  deem  advisable 
in  order  to  facilitate  their  inquiries  and  render  them  more 
efficient  in  the  discharge  of  their  duties. 

Federal  reserve  banks  are  vested  with  the  right  to 


Government  and  Banking  195 

examine  their  members  and  they  receive  from  the  comp- 
troller of  the  currency  information  regarding  the  con- 
dition of  these  members  which  has  been  gathered  for 
him  by  national  bank  examiners. 

The  federal  reserve  banks  themselves  are  examined 
by  examiners  in  the  employ  of  the  Federal  Eeserve 
Board. 

Bank  Reports 

Besides  submitting  to  examination  whenever  the  comp- 
troller may  order  it  to  be  made,  the  national  banks  are 
required  to  turn  in  five  or  more  reports  every  year 
according  as  the  comptroller  may  demand.  These 
reports  are  always  made  for  some  past  date.  Thus,  the 
comptroller  may  on  July  1  telegraph  to  all  the  banks 
requesting  them  to  report  for  the  15th  of  June  preceding. 
This  is  done  in  order  to  restrain  the  banks  from  what 
is  called  * '  window  dressing ' ' — that  is  to  say,  getting  into 
a  temporary  position  that  makes  too  favorable  an 
impression.  The  dates  are  selected  at  somewhat  the 
same  seasons  for  each  year  but  do  not  fall  on  identical 
days  for  obvious  reasons. 

When  the  bank  gets  a  call  from  the  comptroller  it 
fills  out  a  specified  blank  on  which  are  shown  all  the 
items  that  are  deemed  essentially  necessary.  These 
include  capital,  surplus  and  undivided  profits,  deposits, 
notes  outstanding,  amounts  owed  to  other  banks,  loans 
and  discounts,  stocks  and  bonds  held,  amounts  due  from 
other  banks,  specie  and  currency  on  hand,  and  several 
other  items. 

When  the  reports  come  in,  they  are  carefully  tabu- 
lated and  the  aggregate  results  by  cities  and  states  are 
made  public.  This  furnishes  a  body  of  data  five  times 
each  year  for  the  study  of  the  banking  community  and 


196  American  Banking 

enables  careful  bankers  to  see  in  what  direction  the  com- 
munity is  drifting.  They  are  thus  able  to  shorten  their 
loans  or  otherwise  rearrange  their  affairs,  if  they  choose, 
in  accordance  A\dth  the  conditions  that  are  pointed  out 
by  the  general  bank  statement.  Reserve  banks  report 
to  the  Federal  Reserve  Board  each  week,  and  the  report 
is  published.  It  serves  the  purpose  of  showing  the  con- 
dition of  the  nation's  ultimate  reserve-holding  institu- 
tions. 

FimCTIONS   OF    THE    COMPTROLLER 

The  comptroller  of  the  currency,  upon  getting  in  the 
bank  reports,  goes  over  them  either  personally  or  through 
his  subordinate  officials  with  more  or  less  care.  He  notes 
the  cases  where  banks  have  failed  to  live  up  to  the 
requirements  of  law  and  those  in  which  the  banks  are 
acting  unwisely.  He  then  sends  a  letter  of  criticism  or 
instruction  to  the  bank,  noting  the  points  to  which  he 
objects  and  requesting  that  the  institution  shall  get  rid 
of  given  kinds  of  security  or  call  in  certain  classes  of 
paper  or  othei'wise  improve  upon  its  methods.  In  case 
a  bank  proves  restive  or  recalcitrant  the  comptroller  may 
close  its  doors  and  appoint  a  receiver  if  he  thinks  the 
conditions  are  such  as  to  warrant  this  action.  But  of 
course  such  action  is  taken  only  as  a  last  step.  In  certain 
other  cases,  he  may  apply  for  a  forfeiture  of  a  bank's 
charter,  but  this  is  also  an  extreme  remedy  which  is 
rarely  applied  save  in  case  of  great  necessity. 

The  appointment  of  a  receiver  takes  place  when  the 
comptroller  thinks  it  necessary  in  order  to  protect  all 
parties  concerned  and  results  in  the  institution's  passing 
under  the  control  of  the  comptroller  and  his  subordinates. 
A  certain  number  of  banks  are  constantly  in  the  hands 
of  receivers  and  years  may  be  required  to  close  up  their 


Government  and  Banking  197 

business.  The  work  of  the  receiver  ends  when  he  has 
realized  on  the  assets,  paid  off  the  creditors,  and  divided 
the  balance  among  the  stockholders,  or  when  an  accom- 
modation has  been  arrived  at  between  the  bank  and  its 
creditors  so  that  everyone  is  satisfied  and  the  institution 
is  *' restored  to  solvency"  as  the  phrase  goes;  that  is  to 
say,  enabled  to  resume  business  on  a  basis  that  complies 
with  the  requirements  of  law  and  with  the  ideas  of  the 
comptroller  of  the  currency  regarding  the  needs  of  the 
situation. 

The  comptroller,  of  course,  has  charge  of  the  issue  of 
bank  notes  and  the  redemption  and  retirement  of  circula- 
tion, working  in  conjunction  with  the  treasurer  of  the 
United  States.  Every  year,  he  submits  a  report  con- 
cerning the  condition  of  the  national  banking  system  to 
the  speaker  of  the  House  of  Representatives,  who  lays 
it  before  Congress. 

The  Federal  Reserve  Board  likewise  reports  each  year 
to  the  Speaker  of  the  House  of  Representatives.  It 
issues  monthly  the  Federal  Reserve  Bulletin  which  shows 
operations  for  the  preceding  month. 

Control  of  State  Banking  Systems 

Many  of  the  states  have  banking  departments  or  bank- 
ing commissioners  who  preside  over  offices  that  are 
organized  like  that  of  the  comptroller  of  the  currency 
and  stand  in  somewhat  the  same  relation  to  the  state 
banks  of  those  states  that  the  comptroller  of  the  currency 
does  to  the  national  banks.  Inasmuch  as  state  banks  do 
not  now  issue  circulating  notes,  the  duties  of  the  state 
bank  examiners  are  confined  to  looking  into  the  condi- 
tion of  affairs  as  regards  the  loans  and  discounts  and 
other  operations  of  the  banks  to  see  whether  they  comply 
with  the  law  of  that  particular  state  or  not. 


198  American  Banking 

The  fact  that  politics  controls  to  a  greater  extent  in 
the  appointment  of  bank  examiners  and  bank  commis- 
sioners in  certain  states  than  under  the  federal  govern- 
ment has  prevented  some  state  banking  departments  from 
being  as  efficient  as  they  otherwise  would  have  been.  Fur- 
thermore, the  fact  that  the  banks  are  organized  under 
different  laws  would  render  possible  some  failures  to 
secure  co-operation  and  consequently  some  evasions  of 
the  law  by  state  and  national  banks  which  were  not  ready 
to  observe  the  legislative  requirements  to  which  they  are 
subjected.  For  this  reason,  efforts  have  lately  been  made 
to  secure  joint  or  co-operative  action  on  the  part  of  the 
comptroller  and  the  state  banking  departments.  If  this 
proves  to  be  practicable,  the  result  will  be  greatly  to 
strengthen  the  character  of  the  supervision  now  under- 
taken. It  is  also  true  that  the  practice  of  the  state  banks 
and  trust  companies  in  redepositing  their  reserves  with 
the  national  banks  gives  the  latter  a  very  much  better 
control  of  the  situation,  and  hence  renders  the  Federal 
system  more  effective  and  satisfactory  than  it  would 
otherwise  be.  Thus  the  lack  of  co-operation  between 
the  federal  and  state  governments  does  not  produce 
results  as  injurious  as  might  be  expected  under  some 
conditions. 

Direct  Governmental  Control 

At  an  earlier  point  in  the  present  chapter,  reference 
has  been  made  to  the  fact  that,  in  most  countries,  gov- 
ernments exercise  a  direct  participation  in  the  affairs  of 
the  central  banking  mechanism.  In  the  First  and  Second 
United  States  banks,  the  great  chartered  institutions 
which  conducted  the  fiscal  affairs  of  our  government 
during  forty  years  of  its  early  existence  there  was  actual 
government   ownership   of  bank   stock  and  in  foreign 


Government  and  Banking  199 

countries  today  the  government  either  holds  stock  in  the 
central  bank  (as  was  done  by  the  government  of  the 
United  States  in  both  the  First  and  Second  United  States 
banks),  being  represented  on  the  board  of  directors  in 
proportion  to  the  amount  of  its  stock  ownership,  or  it 
may  simply  be  allowed  one  or  more  directors  on  the  board 
who  are  members  thereof  by  virtue  of  a  requirement  of 
the  bank  charter,  although  they  do  not  represent  any 
actual  ownership  of  the  stock.  As  we  have  seen,  the 
latter  plan  is  the  one  adopted  for  the  new  federal  reserve 
banks.  In  such  cases,  the  government  has  an  immediate 
voice  in  the  management  of  the  affairs  of  the  institution 
and  is  able  to  know  everything  about  the  inner  working 
of  the  concern. 

Obviously  this  type  of  control  is  possible  and  desirable 
only  where  the  bank  is  a  large  central  institution  which 
stands  in  direct  relationship  to  the  public  treasury  and 
to  the  currency  circulation,  and  is  therefore  vested  with 
a  kind  of  public  function.  In  the  case  of  such  institu- 
tions, frequent  and  minute  reports  are  made  to  the  board 
of  directors  and  to  the  government  authorities  showing 
just  what  the  bank  is  doing,  and  thus  the  government  is 
enabled  to  exercise  almost  as  close  a  supervision  as  if  it 
were  conducting  the  business  itself. 

Control  of  the  Interest  Rate 

One  species  of  state  control  of  banking  which  is  not 
attempted  in  the  banking  legislation  of  the  United  States^ 
but  which  is  seen  in  some  foreign  countries,  is  the  limiting 
of  the  rate  of  interest  or  discount.  A  good  many  Ameri- 
can states  have  what  are  called  usury  laws,  by  which  it 
is  sought  to  keep  the  rate  of  interest  down  to  a  point  not 
exceeding  a  specified  figure  kno^vn  as  ''the  legal  rate." 
These  laws  have  proved  impossible  of  enforcement,  and 


200  American  Banking 

are  rather  a  hindrance  than  a  help  to  the  establishment 
of  reasonable  rates  of  interest.  In  specifically  limiting 
the  rate  of  discount  at  banks,  it  is  sometimes  sought  in 
foreign  countries  not  to  impose  an  arbitrary  limitation 
but  to  take  some  of  the  surplus  gains  through  a  tax  on 
the  excess  profits  which  are  thus  earned.  It  is  extremely 
doubtful,  however,  wiiether  any  such  regulation  is  in  the 
interest  of  the  borrower  or  of  the  public  at  large. 

The  rate  of  discount  is  essentially  a  thing  to  be  deter- 
mined by  the  interplay  of  commercial  forces ;  and,  as  we 
have  seen  at  an  earlier  point,  it  is  a  weapon  which  can  be 
most  usefully  employed  by  the  bank  in  protecting  its 
reserve  and  which  should  therefore  be  left  as  free  as 
possible,  subject  to  no  restriction.  The  successful  tjT)e 
of  control  for  the  protection  of  stockholder  and  borrower 
depends,  as  has  been  seen,  upon  some  one  of  the  other 
modes  of  regulation  that  have  already  been  described. 

Government  Deposits 

One  reason  why  foreign  governments  protect  their 
banking  systems  with  so  much  care  is  that  the  banks 
in  question  are  the  holders  of  the  public  funds  of  the 
country.  Of  course  the  authorities  could  not  afford  to 
have  these  funds  tied  up  in  an  unavailable  form  even  for 
an  instant,  and  this  supplies  one  powerful  inducement 
toward  strict  regulation.  In  the  United  States,  what  is 
called  the  sub-treasury  system  or  independent  treasury 
system  is  employed  for  keeping  public  funds.  Under 
this  system,  the  funds  of  the  government,  instead  of 
being  deposited  in  banks,  are  supposed  to  be  held  in 
actual  coin  or  currency  in  the  public  Treasury  at  Wash- 
ington or  in  some  one  of  the  so-called  sub-treasuries 
located  at  various  places  throughout  the  country. 

The  government,  however,  has  found  that  in  times  of 


Govermnent  and  Banking  201 

surplus,  tlie  actual  keeping  of  the  coiu  or  currency  in 
its  own  vaults  tends  to  deplete  the  general  stock  of  coin 
or  currency  in  the  country  too  much,  while,  on  the  other 
hand,  greater  convenience  in  business  operations — 
receiving  taxes,  paying  ci"editors,  etc.,  is  attained  by  the 
use  of  banks.  For  this  reason,  it  has  been  found 
necessary  to  employ  certain  banks  as  "government 
depositories."  These  have  varied  in  number  from  a 
very  few  up  to  more  than  1,300,  the  latter  figure  being 
reached  in  1907.  The  government  unfortunately  has  not 
always  distributed  these  deposits  to  the  soundest  banks, 
but  has  sought  to  protect  itself  against  possible  loss  by 
requiring  such  banks,  before  receiving  the  government 
funds,  to  deposit  in  trust  with  the  Treasury  an  equal 
amount  in  approved  bonds.  Then  when  the  government 
funds  are  withdrawn  from  a  particular  bank,  an  equiva- 
lent amount  of  bonds  is  released  by  the  Treasury  and 
may  be  taken  back  by  the  bank  that  deposited  them. 
Thus  the  depositary  banks  of  the  United  States  are  not 
more  carefully  inspected  or  looked  after  than  any  other 
banks.  Some  secretaries  of  the  Treasury  have  endeav- 
ored to  control  the  banks  and  induce  them  to  abstain  from 
certain  practices  by  threatening  to  recall  deposits,  but 
tliis  plan  has  never  worked  very  successfully. 

Under  the  Federal  Reserve  Act  provision  has  been 
made  for  depositing  the  funds  of  the  government  with 
federal  reserve  banks.  Acting  upon  the  power  delegated 
to  him  in  this  respect,  the  Secretary  of  the  Treasury  has 
designated  the  reserve  banks  as  fiscal  agents  of  the 
government. 

GrOVERNMENT   Am   TO   BaNKS 

Out  of  the  conditions  sketched  in  the  last  section  has 
grown  a  system  of  government  aid  to  banks  in  the  United 


202  American  Banking 

States.  At  times  when  there  is  a  large  surplus  in  the 
Treasury  or  when  the  banks  throughout  a  given  section 
of  the  country  have  become  ** over-extended" — that  is  to 
say  have  made  more  loans  than  they  ought  to  have  made, 
considering  their  reserves,  etc. — the  government  is  some- 
times urged  to  step  in  and  aid  them.  This  it  is  asked  to 
do  by  letting  out  some  of  the  cash  it  has  in  the  Treasury, 
thus  raising  the  reserves  of  the  banks  and  so  enabling 
them  to  lend  more  freely. 

There  is  no  reason  why  the  government  should  ever 
do  this  in  the  case  of  any  one  bank,  but  there  may  be 
conditions  existing  over  a  large  area  when  the  state  of 
affairs  in  the  community  generally  calls  for  aid  of  this 
kind  in  order  to  prevent  embarrassment  and  general  lack 
of  bank  credit.  If  such  a  state  of  affairs  does  exist,  there 
may  be  occasions  when  "relief"  of  the  kind  referred  to 
will  be  desirable  or  necessary.  This,  however,  is  true 
only  because  of  the  artificial  shortage  of  currency  which 
has  been  caused  by  the  action  of  the  government  itself 
in  w^ithdrawing  funds  and  keeping  them  stored  in  its 
own  vaults.  Under  such  conditions  the  placing  of  the 
funds  in  banks  is  merely  a  restoration  to  the  channels  of 
trade  of  some  funds  which  the  banks  would  otherwise 
have  had  anyway  and  which  are  needed  by  the  community 
for  the  purpose  of  prosecuting  its  enterprises  and  getting 
the  loans  it  required.  The  trouble  is  that  the  govern- 
ment, in  placing  these  funds  in  banks,  necessarily  acts 
in  an  artificial  manner,  since  it  is  not  able  to  know  just 
where  the  funds  would,  in  the  natural  course  of  things, 
have  gone.  Therefore,  its  bank  deposits  are  always  more 
or  less  artificially  placed  and  they  are  likely  to  go  to 
those  banks  that  do  not  need  them  rather  than  to  the 
banks  which  do  need  them  and  which  would  have  received 
them  in  the  natural  course  of  events  had  not  the  govern- 


Government  and  Banking  203 

ment  insisted  upon  having  them  paid  to  it  in  cash  when 
taxes  and  other  dues  were  originally  liquidated. 

The  effect  may  be,  when  the  government  undertakes  to 
relieve  conditions  iji  this  way,  that  it  places  the  funds 
in  a  manner  that  temporarily  hurts  rather  than  helps 
the  situation.  In  consequence,  a  period  of  readjustment 
is  sometimes  needed  before  the  desired  benefit  is  receivd 
from  such  deposits.  So  also  when  the  funds  are  with- 
drawn from  such  banks  the  consequences  may  be 
injurious  because  of  the  sudden  depletion  of  the  reserve. 
This  makes  it  necessary  for  the  government  to  exercise 
a  good  deal  of  care  both  in  depositing  its  funds  and 
withdrawing  them,  if  it  wishes  to  avoid  injury  to  the 
banking  system.  When  the  functions  of  the  federal 
reserve  banks  are  fully  developed  and  they  are  completely 
performing  their  duties  as  fiscal  agents,  such  aid  will  be 
no  longer  needed. 


TEST  QUESTIONS 

1.  Account  for  the  fact  that  governmental  control  of  banking 
operations  is  a  well-established  fact  in  all  progressive  countries. 

2.  Name  three  primary  objects  of  such  control. 

3.  What  principles  of  regulation  are  used  to  accomplish  each 
end? 

4.  What  are  some  of  the  typical  restrictions  and  regulations 
placed  on  loans? 

5.  Explain  how  regulation  of  loans  helps  to  protect  reserves. 

6.  How  does  the  Federal  Reserve  Act  charge  the  member 
banks  with  responsibility  on  paper  offered  for  rediscount? 

7.  By  what  administrative  devices  are  banking  laws  and  regu- 
lations enforced? 

8.  Explain  the  system  of  bank  inspection  which  prevails  in 
the  national  banks  and  in  the  federal  reserve  banks. 


204  American  Banking 

9.  "What  are  the  chief  problems  in  connection  with  the  exam- 
ination of  state  banks  ? 

10.  "What  kind  of  governmental  control  is  exercised  over  inter- 
est rates?     "What  is  the  purpose  of  such  control? 

11.  What  special  problems  of  contrd  are  involved  when  the 
government  itself  is  a  depositor  at  a  bank  ? 

12.  What  has  been  the  policy  of  the  United  States  in  regard  to 
deposits  at  national  banks?  How  has  the  system  been  modified 
under  the  Federal  Reserve  Act  ? 


CHAPTER  XIV 

HISTORY  OF  BANKING  IN  THE  UNITED  STATES 

While  there  is  not  much  use  studying  banking  from 
the  standpoint  of  ancient  history,  or  in  an  antiquarian 
way,  it  is  of  considerable  importance  to  understand  how 
existing  banking  institutions  have  developed  and  what 
is  the  practice  in  regard  to  banking  in  other  countries  of 
the  world.  It  is  by  such  study  that  the  existing  banking- 
problem  is  properly  apprehended  and  that  the  founda- 
tion is  laid  for  a  suitable  understanding  of  what  should 
be  done  in  the  way  of  legislation  for  the  improvement 
of  present  methods. 

The  nineteenth  century  is  a  period  exceedingly  rich  in 
banking  experience.  During  that  century,  an  immense 
number  of  banking  systems  were  tried,  and  theory  after 
theory  was  taken  up,  applied,  and  discarded.  So  also  in 
the  matter  of  practice  a  great  transformation  was 
brought  about  and  banking  methods  were  almost  revolu- 
tionized. This  makes  the  banking  history  of  the  nine- 
teenth century  of  very  great  value  to  the  student  of  the 
subject  from  the  practical  standpoint. 

In  the  United  States,  a  rev'iew  of  banking  history  will 
show  that  many  of  the  numerous  schemes  and  proposals 
now  brought  forward  from  time  to  time  as  orignnal,  have 
been  tried,  worked  out,  and  thrown  aside.  Here  and 
there  a  good  plan  or  system  has  been  discarded  for  inade- 
quate reasons  and  an  outline  of  past  efforts  shows  why 

205 


206  American  Banking 

the  changes  then  introduced  were  unwise,  and  why  a 
return  to  some  method  then  discarded  may  be  beneficial. 

First  Bank  of  the  United  States 

When  the  government  of  the  United  States  was  first 
organized,  it  found  that  banking  institutions  were  ahnost 
entirely  lacking  in  this  country.  Owing  to  the  bad  con- 
dition of  the  currency  and  the  disorganization  of 
commercial  credit,  there  was  a  strong  desire  that  the 
government  should  participate  actively  in  restoring  busi- 
ness to  a  condition  of  greater  soundness  and  particularly 
that  it  should  aid  in  establishing  a  banking  system  upon 
a  working  basis.  At  that  time,  the  dominant  banking 
idea  in  European  countries  was  that  of  large  chartered 
banks  standing  close  to  the  government.  There  was  such 
an  institution  in  England,  and  Alexander  Hamilton,  who 
was  the  conspicuous  figure  in  our  government  so  far  as 
concerned  all  matters  of  finance,  recommended  the  estab- 
lishment of  a  strong  government  institution  to  handle 
the  finances  of  the  govermnent,  issue  bank  notes,  and 
generally  act  as  a  conservative  and  unifying  influence 
in  the  financial  system  of  the  country.  Such  a  bank  was 
chartered  and  went  into  operation  in  1791.  This  was 
the  First  Bank  of  the  United  States.  A  twenty-year 
charter  was  granted  to  it.  This  charter  followed  very 
much  the  same  lines  that  had  been  recommended  by 
Hamilton  in  his  famous  report.  The  details,  of  course, 
were  shaped  in  Congress  to  suit  the  necessities  of  the 
situation  but,  the  main  ideas  are  clearly  recognizable. 

The  bank  was  given  a  capital  of  $10,000,000  divided  into 
25,000  shares,  of  $400  each.  Of  this  sum  $8,000,000  was 
open  to  subscription  by  the  public,  while  the  other 
$2,000,000  was  to  be  subscribed  by  the  United  States  and 
paid  in  ten  equal  annual  installments  with  interest  at 


History  of  Banking  207 

6  per  cent.  The  subscriptions  to  tlie  stock  were  to  be 
paid  one-fourth  in  specie  and  three-fourths  in  govern- 
ment 6  per  cent  bonds.  Each  shareholder  was  entitled 
to  cast  one  vote  for  one  share,  one  vote  for  the  next  two 
shares,  etc.,  up  to  30  votes,  which  was  practically  the 
maximum  vote  that  could  be  cast  by  any  one  man.  The 
power  to  inspect  all  the  affairs  of  the  bank  except 
the  accounts  of  private  individuals  was  given  to  the  head 
of  the  Treasury,  and  he  was  also  authorized  to  call  for 
reports  as  often  as  once  a  week  if  he  chose.  The  notes 
were  made  receivable  for  public  dues  as  long  as  they 
continued  to  be  payable  in  gold  and  silver.  The  bank 
was  allowed  to  establish  branches  wherever  the  directors 
thought  fit,  but  only  for  discount  and  deposit.  No  trade 
of  any  kind  could  be  engaged  in  and  the  bank  was  not 
allowed  to  hold  real  estate,  though  it  might  lend  on  mort- 
gage security,  while  it  was  not  permitted  to  become 
indebted  for  a  greater  amount  than  its  deposits.  This 
practically  limited  the  issue  of  notes  to  an  amount  not 
in  excess  of  the  capital  stock.  The  bank  was  to  transact 
the  fiscal  business  of  the  government,  and  in  return  it 
was  given  an  exclusive  charter  for  twenty  years. 

The  capital  of  the  bank  was  almost  instantly  sub- 
scribed, and  the  institution  promptly  went  into  operation. 
It  proved  to  be  a  great  success,  rendering  the  currency 
of  the  country  much  more  stable,  supplying  the  needed 
banking  accommodation,  and  providing  a  note  currency 
which  was  on  the  whole  quite  satisfactory.  It  was  very 
successful  in  controlling  the  state  institutions  and  assur- 
ing prompt  payment  of  their  obligations,  especially  of 
the  circulating  notes  issued  by  them.  In  transacting  the 
government's  business,  making  loans  as  desired,  etc.,  it 
met  the  necessities  of  the  situation  very  satisfactorily. 

There  was,  nevertheless,  a  considerable  opposition  to 


208  American  Banking 

the  bank  from  the  first,  and  this  grew  stronger  as  the 
time  came  for  the  expiration  of  the  charter.  The  bank 
stockholders  were  of  course  desirous  of  continuing  and 
as  early  as  1808  they  petitioned  for  a  renewal.  Their 
application  was  supported  by  Secretary  of  the  Treasury 
Gallatin  who  showed  that  the  government  had  made  a 
handsome  profit  on  its  stock  besides  earning  dividends 
averaging  8%  per  cent  per  annum.  The  bank  was  in  an 
exceedingly  strong  position  at  this  time,  as  it  had  on 
hand  about  $5,000,000  in  specie  while  its  loans  and  dis- 
counts w^ere  $15,000,000  and  consisted  chiefly  of  short- 
term  paper.  The  opposition  was  due  to  the  fact  that  a 
large  proportion  of  the  shares  were  owned  abroad  and 
that  the  profits,  therefore,  went  to  foreign  stockholders, 
while  the  antagonism  of  the  state  banks,  which  had  been 
growing  in  number,  was  very  strong.  After  a  bitter 
struggle.  Congress  declined  to  renew  the  charter,  and  the 
bank  went  out  of  existence  at  the  expiration  of  the 
original  charter  in  1811.^ 

Eaely  Growth  or  State  Banking 

It  was  an  unfortunate  time  at  which  to  make  a  change 
in  the  system  of  banking.  The  war  of  1812  was  on  the 
point  of  breaking  out,  and  the  government  had  reached 
a  stage  where  it  more  than  ever  needed  the  aid  of  a 
strong  financial  institution.  The  removal  of  the  First 
Bank  of  the  United  States  took  away  the  check  that  had 
been  imposed  upon  the  small  state  banks,  and  the  result 
was  that  their  issues  were  largely  inflated  during  the 
years  immediately  following  the  cessation  of  the  bank's 
operations.  Added  to  this  was  the  fact  that  the  govern- 
ment speedily  fell  into  a  condition  of  disordered  finance 
and  was  obliged  to  borrow  from  the  state  banks  and  then 
to  sell  bonds  wherever  it  could,  finally  resorting  to  issues 


History  of  Banking  '    209 

of  so-called  ** treasury  notes"  which  were  really  sraall 
United  States  bonds  that  ultimately  degenerated  into  a 
kind  of  currency.  Finally  conditions  became  so  bad  that 
proposals  were  put  forward  for  the  organization  of  a 
new  bank  of  the  United  States ;  and,  after  the  failure  of 
several  proposals  of  this  sort,  Congress  succeeded  in 
passing  a  new  charter  in  1816. 

Second  Bank  of  the  United  States 

The  Second  Bank  of  the  United  States  was  modeled 
very  closely  upon  the  plan  which  had  worked  so  suc- 
cessfully in  the  case  of  the  First  Bank.  The  capital  was 
$35,000,000,  one-fifth  to  be  subscribed  by  the  government, 
while  one-fourth  of  the  public  subscriptions  was  required 
to  be  in  coin  and  three-fourths  either  in  coin  or  govern- 
ment securities.  In  order  to  be  assured  of  an  exclusive 
charter  for  twenty  years,  the  bank  was  to  pay  the  gov- 
ernment a  bonus  of  $1,500,000.  Public  deposits  were  to 
be  made  in  the  Bank  of  the  United  States  unless  the 
Secretary  of  tlie  Treasury  should  order  otherwise,  laying 
his  reasons  for  such  order  before  Congress  at  its  next 
session.  In  the  event  of  failure  to  pay  notes  or  deposits 
on  demand  in  specie,  the  bank  was  to  be  obliged  to  pay 
12  per  cent  annually  on  the  amount  of  its  obligations  thus 
refused. 

There  was  no  trouble  in  selling  the  shares,  but  when 
they  had  been  sold  the  subscriptions  came  in  slowly. 
The  original  charter  had  provided  that  individuals  should 
pay  their  subscriptions  30  per  cent  when  subscribing,  35 
per  cent  in  six  months,  and  35  per  cent  in  twelve  months. 
When  the  time  came  for  the  payment  of  the  second 
installment,  the  specie  came  in  only  to  a  small  extent, 
and  when  the  third  installment  fell  due,  very  few  of 
those  who  owed  it  met  their  obligations  on  time.     Tlio 


210  American  Banking 

bank  discounted  the  notes  of  stockholders  to  a  large 
amount,  and  made  loans  on  its  own  shares  to  a  substan- 
tial extent. 

The  effect  of  all  this  was  to  throw  the  institution  prac- 
tically into  a  condition  of  insolvency,  and  it  required 
strenuous  effort  to  get  back  to  a  working  basis.  Such  a 
basis  was,  however,  established  by  1819;  and,  through  an 
arrangement  with  the  leading  state  banks,  resumption  of 
specie  payments  (which  had  been  suspended  during  the 
war  of  1812)  was  accomplished.  From  the  time  that 
the  bank  was  placed  in  sane  hands,  however,  it  began  to 
apply  a  rigid  system  of  control  to  the  state  institutions 
and  insisted  on  their  keeping  their  notes  redeemed  in 
coin  upon  presentation.  Branches  were,  established  here 
and  there  as  needed  and  the  note  currency  issued  by  it 
became  a  practically  universal  circulating  medium. 
Although  the  bank  carried  on  various  operations  that 
were  probably  outside  the  scope  of  its  charter  and  did 
not  conform  altogether  closely  to  the  limitations  with 
respect  to  methods  of  issuing  circulating  notes,  it  was 
undoubtedly  the  most  powerful  and  best-managed  finan- 
cial institution  the  country  had  seen,  and  its  effect  was 
to  supply  a  far  greater  soundness  and  a  far  higher  degree 
of  convenience  and  efficiency  in  making  payments  than 
had  ever  before  been  experienced.  "" 

The  Second  Bank,  however,  like  its  predecessor,  fell 
into  difficulties  because  of  political  opposition.  There 
was,  as  usual,  the  antagonism  of  the  state  banks,  which 
were  restive  under  the  restraining  authority  of  the  over- 
shadowing federal  institution  and  desired  to  see  it  done 
away  with  that  they  might  get  more  business  and  be  freer 
to  do  as  they  chose.  Beside  this  there  were  large  gen- 
eral influences  of  a  political  character  militating  against 
the  bank,  and  the  persistent  opposition  of  President  Jack- 


History  of  Banking  211 

son  focused  all  this  antagonism  in  an  irresistible  way.  A 
recharter  was  consequently  refused,  just  as  in  the  case 
of  the  First  Bank. 

The  bank  then,  in  1836,  obtained  a  charter  for  thirty 
years  from  the  state  of  Pennsylvania,  thus  becoming  a 
state  institution  and  retaining  its  original  $35,000,000  of 
capital.  Up  to  this  point  the  bank  had  occupied  a  thor- 
oughly sound  position,  but  it  now  found  itself  with  too 
large  a  capitalization  for  the  more  restricted  field  in 
which  it  was  compelled  to  operate.  The  result  was  that 
loans  of  doubtful  character  were  undertaken  and  finally 
the  bank  was  obliged  to  suspend  and  go  into  liquidation 
in  1841. 

Lessons  of  Central,  Bank  Experience 

The  experience  of  the  First  and  Second  United  States 
Banks  is  of  great  interest  at  the  present  time  on  account 
of  the  tendency  toward  centralized  banking  control.  It 
,  should  be  noted,  of  course,  that  both  the  First  and  Sec- 
ond United  States  Banks  were  institutions  of  a  decidedly 
different  type  from  any  that  exist  or  would  be  likely  to 
exist  at  the  present  day.  Thus,  in  1834,  when  the  Second 
Bank  of  the  United  States  was  in  a  decidedly  flourishing 
condition,  its  loans  were  $55,000,000,  deposits  about 
$11,000,000,  circulation  about  $19,000,000  and  specie 
about  $10,000,000.  It  thus  had  approximately  one-third 
of  its  circulation  and  deposits  in  the  form  of  specie,  while 
circulation  was  w^ell  toward  double  the  amount  of  the 
deposits.  This  is  undoubtedly  a  different  condition  from 
that  which  would  be  exhibited  by  any  such  bank  at  the 
present  time.  Its  methods  of  doing  business  were  also 
radically  different  from  those  that  would  be  followed 
today.  The  lessons  that  can  be  obtained  from  the  his- 
tory of  the  First  and  Second  Banks  do  not  lie  along  the 


212  American  Banking 

liue  of  routine  banking  business,  but  are  rather  to  be 
found  in  connection  with  the  type  of  government  control 
and  the  relation  between  the  central  banks  and  the  local 
banks. 

It  is  plain  that  political  questions  will  always  be  of  con- 
siderable importance  in  connection  with  any  government 
bank,  and  as  in  the  case  of  the  First  and  Second  Banks 
they  proved  destructive,  so  they  might  wreck  any  gov- 
ernmentally  controlled  central  bank.  Whether  these 
questions  would  be  rendered  easier  of  solution  by  allow- 
ing the  small  local  banks  to  own  the  stock  of  the  national 
bank  and  thereby  eliminate  their  jealousy  in  a  measure 
as  well  as  some  portion  of  the  political  controversy  con- 
nected with  such  an  institution,  is  a  doubtful  point. 

The  experience  of  the  central  banks  shows  that  very 
excellent  results  could  be  obtained  by  giving  to  such  an 
institution  the  management  of  public  funds  and  intrust- 
ing it  with  the  duty  of  making  transfers  and  carrying- 
on  those  portions  of  the  fiscal  duties  of  the  government 
that  are  distinctly  of  a  banking  type.  Experience  with 
both  these  banks  also  shows  the  good  results  that  can  be 
obtained  through  the  issue  of  a  uniform  bank-note  cur- 
rency, elastic  in  character,  but  amply  secured  by  sound, 
short-time  commercial  paper  accepted  in  the  course  of 
an  exceedingly  conservative  loan  and  discount  business. 

Development  of  State  Banking 

While  the  Second  Bank  of  the  United  States  had  been 
running  its  course,  the  various  states  had  been  experi- 
menting with  different  kinds  of  banking  systems,  some 
successfully  and  others  disastrously.  In  the  course  of 
this  experience,  almost  every  type  of  banking  was 
attempted,  and  the  result  was  the  accumulation  of  a 
great  fund  of  experience  as  to  the  best  way  in  which  not 


History  of  Banking  213 

to  conduct  banking.  Among  the  distinct  types  of  bank- 
ing systems,  developed  during  the  first  half-century  of 
our  national  life,  were  the  so-called  New  England  sys- 
tem, the  bond-secured  system  of  New  York,  the  "state 
banks"  (banks  o^^^led  and  operated  by  state  govern- 
ments or  at  all  events  very  closely  controlled  by  them), 
and  the  so-called  "credit  systems"  of  banking.  Of  all 
these  systems  the  one  that  stands  out  as  having  been  con- 
spicuously successful  was  that  established  in  New  Eng- 
land. 

New  England  System 

The  New  England  banks  had  been  chartered  by  the 
several  states  in  which  they  existed,  but  very  shortly 
came  to  feel  a  much  higher  degree  of  community  of  inter- 
est and  to  recognize  a  much  stronger  necessity  for 
co-operative  action  than  did  the  banks  of  any  other  sec- 
tion. This  led  to  the  development  of  a  certain  degree  of 
uniformity  in  the  banking  laws  of  the  New  England 
states.  As  a  result,  there  was  a  large  territory  through 
which  a  sound  and  safe  state  bank  currency  existed  and 
which  formed  a  striking  contrast  to  the  conflicting  and 
largely  imsound  systems  found  in  other  portions  of  the 
United  States. 

The  main  outlines  of  this  so-called  "New  England 
system"  were  as  follows:  Banks  were  allowed  to  issue 
notes  as  they  pleased,  without  any  special  security  behind 
the  note  other  than  the  general  assets  of  the  institution. 
As  a  rule,  however,  they  were  forbidden  to  issue  an 
amount  of  notes  greater  than  100  or  125  per  cent  of  the 
amount  of  their  capital.  The  capital  itself  had  to  be 
actually  paid  up  within  a  reasonable  length  of  time,  and 
in  some  states  the  stockholders  were  required  to  be  liable 
in  case  of  loss  to  an  amount  equal  to  the  amount  of  the 


214  American  Banking 

capital  or  in  some  cases  to  a  greater  amount.  In  Massa- 
chusetts the  banks  were  not  allowed  to  incur  liabilities 
beyond  a  specified  amount,  and  there  was  a  more  or  less 
careful  inspection  and  examination  of  accounts  by  state 
officials.  The  denominations  of  the  bank  notes  were 
pretty  generally  regulated  so  as  to  prevent  the  issuing 
of  too  many  small  notes.  In  this  way  a  fairly  satisfactory 
degree  of  state  control  was  secured,  and  the  business  of 
banking  was  placed  upon  a  very  substantial  basis.  So 
sound  was  the  situation  that  the  New  England  banks  were 
able  to  maintain  specie  pajmients  in  1814,  when  the  other 
banks  of  the  country  suspended.  They  got  into  trouble 
in  the  panic  of  1837  but  were  much  less  affected  than  were 
the  banks  elsewhere,  returning  to  specie  payments  and 
sound  methods  considerably  earlier. 

Suffolk  System 

One  great  element  in  the  success  of  the  New  England 
banks  was  found  in  a  plan  which  was  not  required  of 
the  banks  by  any  law  but  was  the  result  of  voluntary 
co-operation  on  their  part.  This  was  the  so-called  ''Suf- 
folk system  of  redemption."  The  banks  had  found  it 
hard  to  maintain  constant  and  steady  redemption  of 
notes  and  observed  that  the  sounder  institutions  suffered 
from  the  practices  of  those  that  were  willing  to  go  as  far 
as  they  could  in  evading  prompt  redemption  and  in 
resorting  to  more  or  less  questionable  methods.  The 
result  was  a  desire  to  enforce  prompt  redemption  of 
notes,  and  this  was  accomplished  by  the  so-called  "Suf- 
folk system." 

Under  this  system,  the  New  England  banks  joined  in 
establishing  a  redemption  office  in  Boston,  which  was 
carried  on  by  the  Suffolk  Bank.  This  bank  was  incorpo- 
rated in  Boston  in  1818,  and  a  substantial  number  of  the 


History  of  Banking  215 

New  England  banks  joined  in  a  plan  whereby  they  made 
a  permanent  deposit  of  $2,000  each  with  the  Suffolk  Bank 
and  in  addition  such  sum  as  was  needed  for  the  current 
redemption  of  notes.  At  first  the  country  banks  were 
unwilling  to  join  the  system  because  they  found  that  their 
notes  gained  a  wider  circulation  when  they  were  at  a 
slight  discount,  since  in  the  latter  case  they  displaced 
the  notes  of  the  Boston  banks  which  were  naturally  held 
by  the  people  who  received  them  and  who  presented  for 
redemption  the  depreciated  country  notes,  these  being 
paid  out  in  the  course  of  ordinary  business. 

The  essential  work  of  the  Suffolk  Bank,  therefore,  was 
to  retire  all  the  country  notes  it  could  get  hold  of  and 
then  send  them  home  promptly  for  redemption.  When 
the  system  had  got  fairly  started,  it  was  strong  enough 
to  retire  the  notes  of  large  numbers  of  banks  and  thus 
compel  immediate  redemption,  thereby  greatly  limiting 
the  circulation  of  the  banks  that  put  these  notes  out.  The 
country  banks  were  finally  obliged  to  yield  and  to  make 
the  required  deposit  with  the  Suffolk  Bank,  whic-h  there- 
after redeemed  their  notes  at  par  when  presented, 
charged  them  up  to  the  banks  that  had  issued  them,  and 
sent  them  home  whenever  desired. 

This  system  was  tantamount  to  the  establishment  of  a 
clearing  house  for  note  issues  and  practically  offset  the 
notes  of  one  bank  against  those  of  another  in  making 
settlements.  Consequently  it  was  not  long  before  the 
circulation  of  all  the  banks  became  much  less  redundant 
than  it  had  been.  Occasionally  a  bank,  irritated  by  the 
limitation  upon  its  circulation,  withdrew  from  the  sys- 
tem, but  in  such  cases  it  usually  found  that  its  notes  fell 
into  discredit  and  were  received  only  in  the  immediate 
locality  where  it  was  situated.  The  Suffolk  Bank  system 
thus  furnished  a  striking  object-lesson  of  the  good  effects 


216  American  Banking 

of  prompt  redemption  of  bank  notes,  and  this  was  exceed- 
ingly influential  in  later  banking  legislation. 

New  York  Systems 

Early  banking  in  New  York  was  conducted  on  the  same 
general  plan  as  in  the  first  banks  of  New  England — that 
is,  without  any  specific  security  behind  the  notes.  Char- 
ters were  granted  on  a  somewhat  political  basis  by  the 
legislature  during  the  early  years  of  the  state,  but  a  con- 
siderable number  of  defects  appeared,  just  as  was  the 
case  in  New  England  prior  to  the  development  of  more 
uniform  legislation  there  and  the  institution  of  the  Suf- 
folk system  of  redemption.  As  about  thirty  bank  charters 
were  to  expire  between  1829  and  1833,  it  was  considered 
a  favorable  opportunity  for  introducing  a  change.  The 
result  was  the  adoption  of  what  was  called  the  ''safety- 
fund  plan,"  the  banks  being  rechartered  under  this  sys- 
tem. By  the  plan  proposed,  each  bank  had  to  pay  to  the 
treasurer  of  the  state  an  amount  equivalent  to  one-half 
of  1  per  cent  of  its  capital  stock  until  it  had  paid  in 
3  per  cent  of  its  capital.  This  then  was  treated  as  a  joint 
fund  to  make  good  the  liabilities  of  any  insolvent  bank 
if  its  assets  were  inadequate. 

The  fund  proved  to  be  insufiicient  during  the  difficult 
years  after  1837;  and,  consequently,  in  1842,  the  fund 
was  made  applicable  simply  to  the  notes  of  insolvent 
banks,  the  other  liabilities  being  left  to  be  paid  out  of  the 
assets.  This  brought  the  liabilities  that  might  become 
a  charge  against  the  safety  fund  more  nearly  within  the 
control  of  the  fund  itself,  but  it  broke  down  again  in 
1854.  There  had  been  some  opposition  to  the  safety-fund 
plan;  and,  as  a  result  of  a  campaign  for  ''free  banking," 
the  New  York  legislature  passed  the  "free  banking  act" 
on  April  18, 1838. 


History  of  Banking  217 

Under  this  act  any  gi^oup  of  individuals  might  estab- 
lish a  bank  and  issue  notes,  but  they  could  get  the  notes 
only  from  the  state  comptroller  after  depositing  with 
him  bonds  of  the  United  States  or  the  state  of  New  York 
or  of  any  other  state  approved  by  the  comptroller,  while, 
under  certain  circumstances^  they  could  also  issue  notes 
secured  by  bonds  and  mortgages  upon  improved 
productive  real  estate.  There  was  a  considerable  devel- 
opment of  banking  under  this  law,  but  the  note  issues  had 
very  little  elasticity  and  were  not  as  satisfactory  as  those 
of  the  safety-fund  banks.  The  system  was  gradually 
perfected,  however,  until  the  notes  protected  by  special 
deposits  of  securities  were  veiy  safe. 

''State  Banks" 

The  success  of  the  First  and  Second  United  States 
Banks  naturally  led  to  the  growth  of  imitations  and,  in  a 
number  of  states,  banks  modeled  upon  the  federal  insti- 
tutions were  established.  Thus  the  states  of  South  Caro- 
lina, Ohio,  Indiana,  and  some  others  created  institutions 
some  of  which  proved  exceedingly  successful. 

Perhaps  the  best  example  of  banks  of  this  kind  was  the 
institution  established  by  the  state  of  Indiana  in  1834. 
This  bank  had  a  capital  of  $1,G00,000,  one-half  owned  by 
the  state  and  the  other  half  by  private  individuals  though 
the  state  was  in  full  control.  One  parent  institution  at 
Indianapolis  and  ten  branches,  each  with  a  capital  of 
$160,000,  made  up  the  organization.  The  parent  bank  did 
no  business  but  consisted  merely  of  a  president  and  board 
of  directors  who  controlled  the  operations  of  the  branches 
which  thus  constituted  a  system  of  banks.  The  manage- 
ment of  the  bank  was  throughout  careful  and  scientific 
and  the  profits  were  very  handsome.  The  bank  made  its 
loans  largely  through  the  issue  of  notes  and  these  notes 


218  American  Banking 

were  redeemed  in  specie  upon  presentation.  The  hostil- 
ity of  politicians  led  to  the  discontinuance  of  the  bank, 
and  a  free  banking  system  was  established. 

Other  state  banks  worked  along  very  much  the  same 
lines,  and  wherever  the  management  was  honest  and 
careful  and  the  capital  was  bona  fide,  the  result  was 
successful.  In  various  cases,  however,  banks  were  estab- 
lished without  adequate  capital,  their  chief  assets  con- 
sisting of  state  securities  which  were  of  doubtful  value 
and  their  specie  being  limited  in  amount.  In  other  states 
imitations  of  the  New  York  free  banking  system,  with 
requirements  based  on  the  compulsory  deposit  of  bonds 
or  mortgages  with  the  state  authorities,  were  not  infre- 
quent and  of  course  did  not  produce  notes  of  greater 
soundness  than  the  securities  on  which  they  were  based. 
Thus  a  great  many  unsound  banks  issuing  **  bond-secured 
notes"  came  into  existence.  They  were  no  worse  and  no 
better  than  the  banks  that  were  established  after  the 
New  England  plan,  issuing  notes  based  on  the  general 
assets  of  the  institutions  but  unprotected  by  any  special 
deposit. 

Growth  in  Soundness 

Out  of  all  these  conflicting  systems,  there  developed  a 
gradual  tendency  toward  better  banking  conditions  and 
wise  management.  After  the  discontinuance  of  the  Sec- 
ond Bank  of  the  United  States,  there  ensued  a  severe 
panic  starting  in  1837  and  due  in  part  to  umvise  banking 
and  the  undue  extension  of  credit  upon  improper  or  inad- 
equate security.  The  result  was  to  enforce  the  banking 
lessons  that  had  already  been  afforded  and  to  warn  the 
banks  against  repetition  of  the  practices  .which  had  led 
to  inflation  and  disaster.  There  was  a  gradual  improve- 
ment in  methods  between  1840  and  1860.    But  the  e\als 


History  of  Banking  219 

of  a  decentralized,  widely  diffused,  and  uncontrolled  sys- 
tem of  banking  continued  to  exist. 

At  the  opening  of  the  Civil  War,  there  were  more  than 
1,600  kinds  of  bank  notes  in  circulation.  Counterfeits 
were  numerous  and,  except  for  voluntary  arrangements 
made  by  groups  of  banks  among  themselves,  there  was 
nothing  to  compel  any  bank  to  receive  the  notes  of  any 
other  bank.  Redemption  facilities  were  crude  and  poor 
throughout  most  of  the  country,  and  there  was  a  strong 
feeling  in  favor  of  some  change  in  the  direction  of  more 
powerful  central  control  that  would  guarantee  a  more 
uniform  note  issue.  The  need  of  such  control  was  empha- 
sized by  further  banking  difficulties  in  1857;  which, 
although  by  no  means  so  severe  as  those  of  preceding 
periods  of  panic,  were  nevertheless  disturbing. 

Independent  Treasury  System  Established 

Meanwhile  the  government,  discouraged  and  annoyed 
at  the  experience  it  had  had  after  the  discontinuance  of 
the  Second  Bank  of  the  United  States,  had  established  the 
so-called  ''independent  treasury  system."  Prior  to  this 
an  effort  had  been  made  to  fall  back  once  more  upon  the 
state  banks,  the  deposits  of  the  government  formerly 
kept  with  the  Bank  of  the  United  States  being  appor- 
tioned or  distributed  among  a  number  of  banks.  The 
panic  of  1837  and  the  resulting  suspension  embarrassed 
the  government  and  enforced  the  necessity  of  getting 
some  plan  that  would  retain  the  funds  under  real  and 
genuine  control  of  the  federal  administration.  After 
various  expedients  had  been  suggested  and  their  adop- 
tion had  been  unsuccessfully  sought.  Congress  created 
the  independent  treasury  system  which  assumed  substan- 
tially its  present  form  in  1846. 


220  American  Banking 

The  idea  of  tliis  system  was  that  the  government  should 
entirely  dissociate  itself  from  the  state  banks  and  should 
pay  only  coin  and  receive  only  coin.  Whenever  it  had  a 
surplus  or  money  on  hand,  such  funds  were  to  be  kept  in 
specie  in  vaults  provided  for  that  purpose.  It  was  rea- 
soned that  this  would  keep  the  government  entirely 
independent  of  the  banks  and  their  vicissitudes.  The 
system  was  put  into  operation  and  was  carried  on  wdth 
fair  success  down  to  the  opening  of  the  Civil  War.  Dur- 
ing that  time,  expenses  and  incomes  were  not  far  from 
being  in  a  condition  of  equilibrium,  and  the  system 
worked  with  comparative  smoothness. 

It  was  evident,  however,  even  at  that  comparatively 
early  date,  that  conditions  might  easily  arise  under  wliich 
the  sub-treasury  system  would  not  be  feasible.  It  was 
seen  that,  should  there  be  a  heavy  surplus,  it  would  inev- 
itably operate  to  draw  out  of  the  circulation  and  out  of 
the  banks  a  substantial  percentage  of  the  money  of 
the  country,  retiring  it  from  use  until  such  time  as  the 
government  should  see  fit  to  pay  it  out  again  in  the 
ordinary  course  of  its  business.  Because  the  amount  of 
government  transactions  was  not  very  large,  and  because 
taxes  were  correspondingly  light,  while  a  fair  adjust- 
ment of  revenue  to  expenditure  had  been  obtained,  this 
was  not  an  immediate  or  pressing  question,  but  every 
observer  closely  familiar  with  the  conditions,  recognized 
that  such  a  situation  might  easily  develop,  and  that  the 
sub-treasury  system  would  then  become  an  extremely 
difficult  means  of  managing  the  fiscal  affairs  of  the  gov- 
ernment. The  Civil  War,  therefore,  found  the 
government  with  its  fiscal  system  entirely  divorced  from 
the  banking  system  of  the  country  and  with  the  banks 
disorganized  and  subject  to  no  uniform  or  joint  control. 


History  of  Banking  331 

Banks  and  the  Treasury 

At  the  opening  of  the  Civil  AVar,  it  was  promptly  seen 
that  very  definite  fiscal  expedients  would,  have  to  be 
adopted.  The  customs  duties  fell  off  as  soon  as  the  war 
came  on;  and,  as  these  had  been  the  principal  source  of 
revenue,  the  federal  administration  was  sadly  in  need  of 
funds.  It  undertook  to  borrow  money  from  the  banks 
and  then,  although  Congress  had  granted  permission  to 
suspend  the  Independent  Treasury  Act  in  certain 
respects,  the  administration  insisted  on  drawing  out  the 
installments  of  the  loan  from  the  banks  which  had  agreed 
to  make  it.  The  banks  had  expected  that,  instead  of 
being  compelled  by  the  Treasury  to  pay  coin  as  they 
would  under  ordinary  circumstances  have  had  to  do,  they 
would  be  allowed  to  keep  the  funds  on  deposit  in  their 
vaults  and  simply  transfer  them  at  the  government's 
order  to  public  creditors.  The  effect  of  drawing  off  the 
specie  from  the  banks  and  placing  it  in  the  Treasury  was 
to  w^eaken  the  reserves  and  finally  to  lead  to  a  suspension 
of  specie  payments,  the  banks  refusing  to  pay  out  gold 
or  silver  on  demand. 

Meanwhile  the  necessities  of  the  government  had  been 
mounting  very  rapidlj''  and  it  had  been  unwisely  deter- 
mined to  issue  legal-tender  Treasury  notes  (popularly 
known  as  ''greenbacks").  The  first  issue  of  these  notes 
came  out  in  1862  and  was  followed  by  other  issues.  As 
the  notes  were  legal  tender  they  could  be  used  in  redeem- 
ing bank  notes.  They  took  the  place  of  gold  and  silver 
coin,  these  metals  being  retired  from  circulation  and 
hoarded  or  exported.  The  result  was  that  the  country 
was  speedily  placed  on  a  basis  of  irredeemable  paper.  It 
was  now  without  a  metallic  circulation,  without  any  large 
financial  institution  on  which  to  fall  back,  without  any 


222      '  American  Banking 

uniform  bank-note  currency,  and  without  any  substantial 
control  over  the  banks.  The  constant  and  enormous 
demand  for  funds  with  which  to  carry  on  the  war  could 
not  be  satisfied  by  any  other  means  than  huge  loans  on 
long  time,  accompanied  by  heavy  taxation  designed  to 
supply  the  funds  for  paying  the  interest  on  the  bonds  and 
ultimately  redeeming  them  as  they  fell  due.  In  endeavor- 
ing to  sell  such  bonds,  the  federal  government 
encountered  lamentable  difficulty  and  was  driven  to 
various  expedients  for  pushing  the  securities  into  the 
hands  of  buyers. 

Among  other  schemes  that  suggested  themselves  to  the 
Treasury  authorities  was  that  of  organizing  a  banking 
system  similar  to  the  free  banking  system  of  the  state 
of  New  York.  The  basic  idea  of  this  system  was  that  of 
allowing  the  banks  to  issue  notes  on  condition  that  they 
should  deposit  with  the  Treasury  securities  in  proper 
amount  to  protect  the  notes  they  issued.  It  was  supposed 
that  by  requiring  them  to  buy  United  States  bonds  to 
serve  in  this  capacity,  the  government  might  create  a 
strong  demand  for  such  bonds  and  that,  as  a  result,  it 
would  be  found  easier  to  sell  the  securities,  while  their 
price  would  probably  be  proportionately  better. 

On  the  other  hand,  it  was  argued,  this  system  wouW 
be  so  popular  that  the  state  banks  would  be  unable  to 
compete  with  it.  They  would  rush  into  the  system  and 
consequently  the  country  would  be  supplied  with  a  uni- 
form currency,  issued  by  a  set  of  banks  directly  under  the 
control  of  the  national  government,  responsible  to  that 
government  and  purchasing  its  bonds  as  a  basis  for  the 
issue  of  its  notes.  This  was  the  fundamental  idea  upon 
which  the  present  national  banking  system  was  based.  It 
was  designed  primarily  as  a  device  of  national  finance 
rather  than  as  a  service  to  industry. 


,  History  of  Banking  223 

>      TEST  QUESTIONS 

1.  What  is  the  object  of  studying  the  history  of  banking  ? 

2.  "Why  is  the  history  of  the  nineteenth  century  especially 
rich  in  experience  ? 

3.  "What  was  the  nature  of  the  first  bank  of  the  United  States  ? 
How  was  it  organized?  "What  was  its  relation  to  the  govern- 
ment? 

4.  "What  two  great  Americans  are  associated  with  our  early 
banking  and  financial  systems? 

5.  Give  an  account  of  the  second  bank  of  the  United  States 
and  the  causes  of  its  downfall. 

6.  What  lessons  did  these  early  banking  experiences  give  us  ? 

7.  Explain  the  main  features  of  the  New  England  system  of 
banks. 

8.  What  did  the  Suffolk  Bank  attempt  to  accomplish? 

9.  What  were  the  essential  features  of  the  New  York  systems  ? 

10.  Explain  the  attempts  to  establish  genuine  "state"  banks. 
After  what  were  they  modeled  ? 

11.  What  is  meant  by  the  independent  treasury  system? 

12.  What  causes  lead  to  the  adoption  of  the  independent  treas- 
ury system  in  American  public  finance  ? 


CHAPTER  XV 
the  national  bank  act 

Natuee  of  the  Act 

The  first  act  'Ho  jDrovide  a  national  currency  secured 
by  a  pledge  of  United  States  stock  and  to  provide  for 
the  circulation  and  redemption  thereof"  became  a  law 
February  25,  1863.  This  was  found  defective  in  some 
particulars  and  was  amended  during  the  following  year. 
The  Act  contained  most  of  the  provisions  which  had  been 
found  necessary  in  the  experience  with  state  banks  dur- 
ing preceding  years.  It  provided  for  inspection  and 
examination  on  the  part  of  the  federal  government 
through  a  currency  bureau,  for  the  maintenance  of 
reserves,  the  redemption  of  notes  over  the  counter  of  the 
issuing  bank  and  at  agencies  in  certain  principal  cities, 
for  the  conversion  of  state  banks  into  national  banks, 
for  the  deposit  of  public  moneys  in  banks  when  necessary 
upon  security  of  United  States  bonds,  for  the  taxation  of 
the  banks,  and  numerous  other  points,  some  of  the  more 
important  of  which  have  already  been  mentioned  in  fore- 
going discussions. 

The  striking  feature  of  the  Act  was  seen  in  the  pro- 
^^sions  which  controlled  the  objects  for  which  it  had 
been  created  and  which  governed  the  methods  of  note 
issue  in  a  certain  degree.  The  banks  were  required  to 
buy  government  bonds  as  an  incident  to  their  receiving 
charters.  At  least  25  per  cent  of  the  amount  of  the  cap- 
ital had  to  be  put  into  government  bonds  by  the  smallest 

224 


National  Bank  Act  225 

class  of  banks.  This  requirement  became  smaller  as  the 
capital  of  the  bank  became  larger,  and  in  the  large  banks 
the  amount  of  bonds  bought  was  a  comparatively  small 
percentage  of  the  capitalization.  Notes  could  be  issued 
to  the  amount  of  90  per  cent  of  the  par  value  of  the  bonds 
held  by  the  institution,  such  bonds  being  in  any  event 
deposited  in  trust  with  the  Treasury  Department.  The 
amount  of  notes  to  be  issued  in  the  aggregate  was,  how- 
ever, limited  to  $300,000,000,  and  this  amount  was  appor- 
tioned to  the  several  states  according  to  population  and 
existing  banking  conditions. 

With  the  comparatively  rigid  restrictions  imposed  by 
the  Bank  Act,  with  the  requirement  that  bonds  be  pur- 
chased, and  with  the  necessity  incumbent  upon  state 
banks  that  they  change  their  names  before  entering  the 
system,  the  existing  institutions  were  somewhat  slow  to 
give  up  their  old  charters  and  reorganize  under  the 
national  law.  The  effect  of  this  hesitation  was  to  prevent 
the  banks  from  rushing  into  the  new  system  as  they  had 
been  expected  to.  Late  in  1864,  there  were  only  584 
banks  in  the  system,  and  they  had  outstanding  a  circula- 
tion of  only  $65,000,000.  The  results  which  were  expected 
in  the  way  of  a  demand  for  United  States  bonds  originat- 
ing with  the  national  banks  were  consequently  not 
realized. 

The  national  banking  system  did  not  materially  influ- 
ence the  demand  for  bonds,  but  the  advantages  arising 
out  of  the  creation  of  a  uniform  currency  were  more  and 
more  generally  recognized,  and  various  administrators 
who  had  opposed  the  plan  at  first,  became  advocates  of  it. 
Some  went  so  far  as  to  urge  that  legislation  be  adopted 
whereby  state  banks  would  practically  be  compelled  to 
cease  issuing  notes,  and  in  harmony  with  such  recommen- 
dations Congress  in  the  Act  of  March  3,  1865,  imposed 


226  American  Banking 

a  tax  of  10  per  cent  on  state  bank  issues  beginning  with 
July  1, 1866.  Thereafter  the  banks  came  into  the  system 
much  more  rapidly  and  there  was  a  considerable  drift 
away  from  the  state  banking  systems.  It  was  speedily 
perceived,  however,  that  the  state  systems,  even  without 
the  power  to  issue  notes,  had  a  place  of  their  own.  Some 
of  the  strongest  state  banks  preferred  to  retain  their 
charters  under  state  laws  and  to  go  on  doing  a  discount 
and  deposit  business. 

Development  of  the  System 

The  power  to  control  note  issues,  and  the  prestige 
resulting  from  federal  supervision,  however,  gave  the 
national  banks  the  lead  and  from  1866  onward  they  were 
rapidly  organized,  extending  into  the  South  as  soon  as 
the  Civil  War  had  closed.  Great  difficulty  was  experi- 
enced in  consequence  of  the  limitation  of  the  note  issues 
to  $300,000,000  in  the  aggregate.  In  1866  the  national 
bank  circulation  amounted  to  about  $280,000,000.  This 
sum  was  very  badly  distributed.  The  wealthier  and  older 
parts  of  the  North  had  secured  a  large  share  of  the  notes. 
In  New  England  much  more  than  the  due  proportion 
belonging  to  them  had  been  acquired  by  the  banks  while 
the  South  was  unable  to  get  much  currency,  notwith- 
standing that  it  was  sorely  in  need  of  some  notes  to  take 
the  place  of  the  Confederate  currency  which  had  driven 
out  specie.  The  maximum  limitation  had  been  set  partly 
because  Congress  feared  that  in  a  time  of  suspension  of 
specie  payments,  such  as  then  existed  throughout  the 
countrj^,  permission  to  issue  notes  up  to  any  amount  of 
bonds  that  the  banks  might  deposit  (not  exceeding  their 
capital)  might  lead  to  an  over-issue  of  bank  notes  which 
would  operate  still  further  to  postpone  the  date  of 
redemption. 


National  Bank  Act  227 

The  national  govei*nment  was,  therefore,  not  willing 
■  to  relieve  the  shortage  of  currency  by  removing  the  limi- 
)  tation,  but  finally  sought  to  help  matters  somewhat  by 
\  enlarging  the  maximum  limitation  to  $354,000,000,  while 
it  was  further  provided  that  $25,000,000  should  be  with- 
drawn from  those  states  that  had  more  notes  than  their 
share  and  issued  to  banks  and  states  which  had  less  than 
their  share.  The  provision  was  so  complex,  and  the  rate 
of  interest  was  so  high  in  the  South  and  West  as  com- 
pared with  the  comparatively  low  interest  earned  on  the 
bonds  which  had  to  be  deposited  in  order  to  get  the  notes, 
that  there  was  relatively  little  disposition  on  the  part  of 
the  southern  and  western  banks  to  act  under  the  law  of 
1870.  In  fact,  this  demand  was  so  slack  that  it  did  not 
prove  necessary  to  withdraw  the  $25,000,000  in  notes 
from  banks  that  had  more  than  their  proportionate  share. 
When  Congress  finally  got  to  the  point,  in  1875,  where 
it  felt  able  to  provide  for  the  resumption  of  specie  pay- 
ments, it  also  dealt  with  the  bank-note  question  by 
repealing  all  limitations  upon  the  issue  of  bank  notes  to 
any  amount,  subject  to  the  general  limitations  and 
requirements  of  the  law  with  reference  to  bonds  and 
capital.  This  change  helped  the  situation  considerably. 
There  was  a  decided  increase  in  the  development  and 
prosperity  of  the  national  system,  and  on  the  other  hand 
a  decided  growth  of  opposition  sprang  up.  The  system 
was,  however,  by  this  time  thoroughly  well  established 
and,  after  the  resumption  of  specie  payments  in  1879, 
the  notes  of  the  banks  were  equivalent  in  value  to  gold 
and  provided  an  unquestionably  stable  and  satisfactory 
currency  so  far  as  questions  of  safety  and  security 
were  concerned.  Changes,  however,  had  occurred  in  the 
fundamental  basis  upon  which  the  national  banking  sys- 


228  American  Banking 

tern  was  founded,  and  the  result  was  a  tendency  to 
decrease  the  amount  of  circulation  outstanding. 

EisE  IN  Price  of  Bonds 

As  has  been  seen,  the  banks  were  required  to  deposit 
$100  in  bonds  for  every  $90  which  they  received  in  notes. 
Supposing  the  bonds  employed  for  this  purpose  bore  6 
per  cent,  it  is  plain  that  a  bank  that  had  $100  in  gold  coin 
or  other  legal-tender  money  could  (if  the  bonds  were  at 
par)  buy  $100  in  bonds,  thus  getting  6  per  cent  interest 
thereon,  deposit  the  amount  with  the  secretary  of  the 
Treasury,  receive  back  $90  in  notes,  and  then  lend  these 
notes  to  borrowers  at  such  a  rate  of  interest  as  they  were 
willing  to  pay.  The  following  of  this  plan  led  in  some 
quarters  to  the  bringing  forward  of  an  argument  now 
very  familiar — that  banks,  by  reason  of  the  bond  deposit 
system,  were  able  to  make  a  ''double  profit,"  inasmuch 
as  they  got  the  interest  on  the  bonds  and  the  interest  on 
the  notes. 

As  a  matter  of  fact,  there  was  no  foundation  for  this 
complaint.  A  ' '  double ' '  profit  is  what  every  banker  has 
to  make  in  order  to  pay  the  special  expenses  of  banking, 
otherwise  he  might  as  well  use  his  capital  in  loans  on 
real  estate  or  other  security.  If  the  banker  had  $100  in 
gold  to  start  with,  he  would  do  very  much  better  for  him- 
self were  he  to  use  the  cash  as  a  reserve  and  simply  make 
his  loans  by  granting  credits  on  his  books  than  he  would 
were  he  to  follow  the  plan  of  buying  bonds  and  getting 
notes  to  be  loaned.  In  practice,  if  the  banker  were  able 
to  lend  four  times  the  amount  of  his  reserve  he  would  get 
the  interest  on  $400  of  loans  and  maintain  a  reserve  of 
$100  in  coin,  while  in  the  national  system  if  he  took  out 
notes  he  would  get  the  interest  on  $100  in  bonds  and  $90 
in  notes  even  if  he  did  not  have  to  supply  a  reserve 


National  Bank  Act  229 

behind  these  notes — which  of  course  he  would  be  obhged 
to  do,  either  in  the  form  of  a  redemption  fund  with  the 
Treasury,  or  as  a  cash  reserve  in  his  vaults. 

It  is  obvious  that  the  higher  the  price  of  the  bonds 
went  the  less  would  be  the  profit  to  be  derived  from  notes 
since,  under  the  original  national  act,  the  banks  could 
only  get  90  per  cent  of  the  par  value.  Thus,  if  bonds 
stood  at  125  it  is  clear  that  the  banker  v>'ould  have  to 
spend  $125  in  order  to  get  a  bond  whose  par  value  was 
$100  and  on  the  strength  of  which  he  could  only  get  $90 
in  notes.  This  would  mean  that  there  was  a  margin  of 
$35  between  the  amount  paid  for  the  bond  and  the  amount 
of  notes  obtained,  on  which  there  was  no  return.  During 
the  years  after  1870,  the  price  of  bonds  steadily  rose  and 
this  process  was  accelerated  after  1875  when  resumption 
was  decided  on. 

A  further  influence  tending  to  stimulate  the  price  of 
bonds  came  from  the  redemption  of  portions  of  the  debt 
out  of  surplus  revenues.  Not  only  did  the  issue  of  circu- 
lation become  less  profitable  to  the  banks,  but  they  also 
saw  opportunities  for  making  a  substantial  profit  by 
selling  their  bonds  at  the  higher  prices  that  had  become 
the  rule.  Under  the  influence  of  these  conditions,  the 
national  circulation,  which  had  risen  to  about  $350,000,- 
000  at  the  end  of  1873,  fell  off  nearly  $50,000,000  during 
the  succeeding  three  years.  Subsequently,  there  was  a 
slight  expansion,  and  then  the  reactionary  movement  set 
in  once  more.  In  1879 — the  resumption  year — the  circu- 
lation was  only  $323,000,000. 

Congress  was  now  under  the  influence  of  the  anti-bank- 
ing sentiment  which  had  developed  throughout  the 
country,  and  in  1881  passed  a  bill  requiring  3  per  cent 
bonds  which  were  to  be  issued  for  the  purpose  of  refund- 
ing the  national  debt  to  be  used  by  the  banks  as  security 


230  American  Banking 

for  circulation.  Other  pro^dsions  in  the  act  would  have 
made  it  difficult  or  impossible  to  reduce  circulation  any- 
further,  and  the  result  was  a  sharp  retirement  of  notes 
in  anticipation  of  the  passage  of  the  law.  The  measure 
was  vetoed  but,  while  a  good  many  bonds  that  had  been 
withdrawn  were  redeposited,  the  movement  toward  the 
curtailment  of  circulation  had  now  definitely  begun. 

Geowth  of  a  Government  Surplus 

The  curtailment  of  bank  currency  under  the  national 
system  which  had  set  in  in  consequence  of  the  natural 
causes  already  set  forth,  which  grew  out  of  the  greater 
prosperity  of  the  country  and  the  more  stable  condition 
of  its  finances,  was  now  to  be  still  further  aided  as  a 
result  of  the  growth  of  a  great  government  surplus.  The 
Treasury  had  been  buying  bonds  and  thereby  reducing 
indebtedness  during  the  later  seventies  as  occasion 
offered.  But  the  process  went  forward  even  more  rap- 
idly after  1880.  Eevenues  were  abundant  and  largely  in 
excess  of  the  amount  needed  for  government  expenses. 
Consequently,  under  the  independent  treasury  law  whose 
features  have  already  been  noted,  only  two  uses  could  be 
made  of  these  excess  funds.  They  might  be  kept  on  hand 
in  money  in  the  vaults  or  they  might  be  deposited  with 
the  banks.  The  latter  operation,  however,  necessitated 
the  depositing  of  government  bonds  with  the  Treasury 
as  security. 

It  was  found  that  if  the  Treasury  used  the  surplus 
funds  to  buy  up  issues  of  bonds  in  the  market  before  they 
were  due  it  raised  the  price  of  the  bonds  so  high  that  it 
became  expedient  for  the  national  banks  to  sell  as  many 
of  their  bonds  as  they  could  and  reduce  their  circulation 
to  as  low  a  point  as  possible,  while  if  the  funds  were 
deposited  in  the  banks,  the  latter  were  obliged  to  buy  the 


National  Bank  Act  231 

bonds  in  order  to  use  them  as  security  with  the  Treasury 
for  the  holding  of  the  deposits.  They  thus  raised  the 
price  of  the  bonds  in  the  market  through  their  own  action 
and  made  it  unprofitable  for  themselves  to  use  such  bonds 
for  the  maintenance  of  outstanding  circulation.  During 
the  years  1881-1891,  the  bonded  debt  of  the  United  States 
was  cut  by  more  than  $1,000,000,000.  The  price  of  the 
bonds  rose  tremendously  and  in  1891  the  lowest  average 
price  was  more  than  124.  The  effect  of  these  changes 
was  instantly  perceived  in  the  national  bank  circulation, 
which  dropped  from  $323,000,000  in  1879  to  $173,000,000 
in  1892.  It  almost  seemed  as  if  the  issue  of  notes  would 
be  cut  to  the  absolute  minimum  corresponding  to  the 
volume  of  bonds  required  by  the  law  to  be  deposited  as  a 
prerequisite  to  the  existence  of  the  banks. 

Deficit  Financieeing 

New  conditions  set  in  after  1890.  The  tariff  act  of 
that  year  had  been  so  drafted  as  to  cause  a  large  decrease 
in  the  annual  net  revenue  and  it  was  shortly  apparent 
that,  instead  of  having  funds  with  which  to  buy  more 
bonds,  the  government  would  have  to  borrow  money  on 
new  bonds.  Conditions  were  complicated  by  the  silver- 
purchase  policy  which  had  been  follow^ed  by  the  govern- 
ment since  1878  and  which  was  carried  further  by  the 
silver-purchase  law  of  1890.  This  policy  contributed  to 
the  panic  of  1893,  although  the  silver-purchase  law  was 
repealed  in  that  year.  Issues  of  new  bonds  were  made  by 
the  government,  during  the  second  Cleveland  administra- 
tion (1893-1897),  to  the  amount  of  some  $252,000,000. 
This  and  the  cessation  of  the  silver-purchase  policy  and 
of  the  issues  of  notes  based  on  silver  by  the  government 
somewhat  helped  the  bank  circulation  to  increase,  and  in 


232  American  Banking 

1896  the  total  notes  outstanding  had  grown  to  about 
$214,000,000. 

Dissatisfaction  with  the  whole  idea  of  a  bond-secured 
currency  had,  however,  begun  to  develop,  and  there  was 
a  demand  for  the  abolition  of  the  bond  deposit  require- 
ment. Secretary  of  the  Treasury  Carlisle  urged  the 
repeal  of  the  bond  deposit  requirement  (1894),  and  Presi- 
dent Cleveland  supported  the  idea  of  real  currency 
reform.  The  same  idea  was  supported  by  representative 
bankers  of  the  country  who,  in  a  convention  in  Baltimore 
in  1894,  put  forward  the  so-called  ''Baltimore  plan,"  in 
which  they  advocated  the  issue  of  circulating  notes  by 
national  banks  without  bond  deposit  up  to  50  per  cent  of 
their  paid-up  capital  secured  simply  by  general  assets 
and  by  a  guaranty  fund  jointly  deposited  by  the  banks 
with  the  United  States  Treasury.  The  ideas  thus  put 
forward  w^ere  far  too  radical  to  gain  a  general  or  sympa- 
thetic hearing  from  the  country  at  large,  which  was  now 
taken  up  with  the  free-silver  agitation  and  was  inclined 
to  condemn  any  plan  which,  in  the  popular  estimation, 
tended  to  afford  a  greater  degree  of  liberty  or  a  greater 
profit-making  opportunity  to  the  banks. 

Although  the  banks  of  the  national  system  continued  to 
grow  in  numbers  and  in  the  amount  of  their  operations, 
the  question  of  banking  legislation  was  thrown  into  the 
background  as  a  result  of  the  preponderating  influence 
of  the  monetary-standard  question,  and,  notwithstanding 
a  party  pledge  in  favor  of  monetary  and  banking  legisla- 
tion given  by  the  Republicans  in  1896,  nothing  was  done 
imtil  the  passage  of  the  so-called  Gold  Standard  Act  of 
1900.  By  that  year  the  number  of  banks  had  increased 
to  3,602  as  compared  with  2,052  in  1880.  The  growth 
since  1890  when  there  were  3,326  banks,  had,  however, 
been  slow  and  there  had  even  been  a  retrograde  move- 


National  Bank  Act  233 

ment  since  189'i,  in  which  year  there  were  3,784  banks. 
Altogetlier,  not  onlj^  the  party  pledge  but  also  the  condi- 
tion of  the  banking  system,  the  slow  growth  of  the 
circulation,  the  high  price  of  bonds,  and  the  fact  that  the 
surplus  problem  was  reappearing  contributed  to  the 
passage  of  legislation  in  1900  in  which  it  was  sought  to 
remedy  some  of  the  difficulties  that  had  already  been 
manifested. 

Act  of  1900 

The  Act  of  1900  made  several  important  changes  in 
the  existing  monetary  and  banking  situation  as  well  as 
in  the  fiscal  organization  of  the  Treasury.  It  will  not  be 
necessary,  however,  to  do  more  than  note  the  particulars 
in  which  it  altered  the  banking  system.  Two  innovations 
of  considerable  importance  were  introduced.  Previous 
to  1900,  $50,000  was  the  smallest  capital  with  which  a 
national  bank  could  be  organized.  This  was  now  reduced 
to  $25,000.  Further,  the  Act  made  provision  for  the 
refunding  of  the  national  debt  into  2  per  cent  bonds 
and  the  use  of  these  bonds  by  the  banks  as  security  for 
their  circulation.  It  also  raised  the  amount  of  bank 
notes  tliat  could  be  issued  against  a  bond  from  90  per 
cent  of  its  par  value  to  100  per  cent.  The  tax  on  notes 
secured  by  2  per  cent  bonds  w^as  also  cut  to  one-half  of 
1  per  cent  instead  of  1  per  cent. 

These  changes  were  of  considerable  importance.  They 
rendered  it  possible  to  get  out  a  much  larger  volume  of 
notes  with  a  given  amount  of  bank  capital,  and  to  that 
extent  rendered  the  note  issue  more  profitable.  This 
removed  some  of  the  checks  which  had  operated  to  keep 
banks  from  organizing  under  the  national  system  rather 
than  under  the  state  systems.  The  banks  entered  the 
system  quite  rapidly  and  there  was  a  particularly  largo 


234  American  Banking 

addition  in  the  $25,000  class.  Starting  with  3,602  banks 
in  1900,  the  number  rose  to  5,528  in  1905  and  7,600  in 
1915.  Nearly  2,400  banks  with  a  capital  of  less  than 
$50,000  were  taken  into  the  system  during  the  seven  years 
succeeding  the  passage  of  the  Act,  and  of  these  a  great 
many  were  state  banks  which  surrendered  their  old  char- 
ters and  became  national  banks  organized  under  the 
direction  of  the  federal  government. 

Surplus  Difficulties 

The  difficulty  with  the  surplus  had  again  reappeared 
and  had  assumed  a  serious  form  as  early  as  1902-03,  con- 
tinuing wdth  some  fluctuations  and  changes  to  cause 
trouble  until  1907.  The  problems  presented  to  the  Treas- 
ury in  relation  to  banking  during  those  years  were  sub- 
stantially similar  to  those  which  had  arisen  during 
preceding  periods  of  the  same  sort.  The  accumulation 
of  funds  in  the  vaults  of  the  government  tended  too 
strongly  to  reduce  the  volume  of  money  in  use,  and  con- 
sequently it  was  desirable  to  get  the  cash  out  into 
circulation  once  more.  However,  the  opportunity  for 
reducing  the  debt  was  now  less  favorable  than  it  had 
pre\'iously  been,  and  the  Department  was  thus  driven  to 
fall  back  upon  deposits  of  government  money  with  the 
banks. 

The  rapid  growth  in  the  national  bank-note  circulation 
from  about  $332,000,000  in  1900  to  about  $666,000,000,  or 
more  than  double  its  original  figure  in  1908,  had  absorbed 
a  large  quantity  of  the  2  per  cent  bonds,  wliile  the  use  of 
bonds  as  security  for  government  deposits  took  another 
large  block.  The  result  was  that  in  the  years  1906  and 
1907  only  a  small  margin  of  available  bonds  that  could 
be  used  for  the  purpose  of  increasing  circulation  in  case 
of  necessity  was  anywhere  to  be  seen.    It  was  plain  that, 


National  Bank  Act  235 

in  the  event  of  difficulty  in  securing  adequate  note  circu- 
lation at  any  time,  it  would  not  be  easy  to  get  relief 
through  the  national  banks,  for  the  reason  that  the  banks 
would  find  it  very  hard  to  buy  many  bonds  on  which  to 
base  note  issues.  This  difficulty  had  been  so  apparent  as 
the  surplus  in  the  banks  grew  larger  that,  notwithstand- 
ing the  existence  of  a  very  large  surplus.  Congress 
authorized  the  Secretary  of  the  Treasury  to  obtain  funds 
for  the  construction  of  the  Panama  Canal  by  issuing 
bonds.  He  was  thus  able  to  supply  some  bonds  when 
needed  as  a  basis  for  bank-note  issues,  but  the  margin 
thereby  provided  was  not  large. 

The  Secretary  of  the  Treasury  subsequently  assumed 
the  authority  to  permit  the  substitution  of  approved 
municipal,  state,  and  railroad  bonds  for  the  government 
bonds  that  were  held  behind  public  deposits.  The  law 
was  too  positive  and  explicit  to  permit  of  his  allowing 
the  substitution  of  these  other  bonds  for  national  bonds 
behind  bank  notes,  but  he  attained  somewhat  the  same 
end  by  substituting  the  outside  bonds  as  a  backing  for 
deposits,  thus  releasing  the  national  bonds  held  for  that 
purpose  and  transferring  them  to  the  account  of  the  bank 
circulation.  It  is  highly  questionable  how  far  these 
measures  were  expedient.  They,  however,  assisted  banks 
in  continuing  the  upward  movement  of  loans  and  dis- 
counts upon  which  they  had  embarked  and  enabled  them 
to  avoid  retrenchments  and  curtailment  except  sporad- 
ically. 

Panic  of  1907 

The  limit  of  the  movement  was  reached  in  1907,  when 
the  banks  had  so  extended  their  loans  that  they  could  go 
no  further,  while  the  Treasury  had  almost  exhausted  its 
power  of  relieving  them  by  depositing  cash  at  moments 


236  American  Banking 

of  stringency.  Starting  with  a  brief  but  acute  panic  in 
the  early  spring,  the  country  gradually  worked  toward  an 
attack  of  depression  and  suffering  of  a  graver  nature. 
This  came  on  in  the  autumn  and  was  characterized  by 
the  same  symptoms  that  had  been  noted  in  previous 
periods  of  like  character.  Banks  the  country  over  were 
unable  to  pay  in  cash,  and  in  the  larger  places  they  were 
obliged  to  resort  to  the  issue  of  clearing-house  certifi- 
cates. The  Treasury  did  what  little  it  could  to  help  the 
depositing  of  its  remaining  cash  with  the  banks,  but  it 
proved  to  be  almost  impossible  to  enlarge  the  bank  cir- 
culation in  any  very  material  degree,  although  some  relief 
was  obtained  by  further  transfers  of  bonds  from  deposit 
account  to  circulation  account  and  the  substitution  of 
non-national  bonds  behind  public  deposits. 

CuERENCY  Legislation  of  1908 

When  Congress  met  in  December,  1907,  it  was  obliged 
to  face  a  strong  demand  from  the  country  generally  for 
legislation  which  would  relieve  existing  conditions  and 
would  make  it  possible  to  get  a  currency  needed  by  the 
banks  at  such  times  as  genuine  demand  might  be  exhib- 
ited. Various  bills  were  introduced,  but  the  two  that 
shortly  assumed  greatest  prominence  were  those  of  Kep- 
resentative  Charles  N.  Fowler  of  New  Jersey,  then 
Chairman  of  the  House  Banking  and  Currency  Commit- 
tee, and  Senator  N.  W.  Aldrich  of  Rhode  Island, 
Chairman  of  the  Finance  Committee  in  the  Senate.  These 
bills  represented  the  two  radically  distinct  points  of  view 
on  the  currency  and  banking  question  whose  development 
we  have  already  traced. 

The  Fowler  bill  embodied  a  great  many  features  that 
would  have  resulted  in  modifying  the  national  banking 
system  at  important  points,  but  in  substance  its  aim  was 


J 


National  Bank  Act  237 

to  create  district  organizations  of  groups  of  banks  which 
were  to  issue  currency  based  simply  upon  the  assets  of 
the  banks.  The  Aldrich  bill  did  little  more  than  to  per- 
mit the  substitution  of  specified  classes  of  outside  bonds 
as  security  behind  future  issues  of  national  bank  notes 
instead  of  the  national  bonds  already  required.  This  idea 
of  course  necessitated  a  tolerably  complex  piece  of  legis- 
lation in  order  to  adjust  the  proposal  to  existing  methods 
of  banking  and  to  the  old  currency  in  such  a  way  as  not 
to  lower  the  value  of  the  national  bonds  which  were 
already  used  as  security  for  bank  notes.  But  the  funda- 
mental object  of  the  law  was  merely  what  has  just  been 
stated. 

The  opposition  between  the  two  proposed  bills  lay  in 
the  fact  that  whereas  the  Fowler  plan  would  have  given 
greater  scope  to  those  banks  which  did  a  "straight"  com- 
mercial paper  business,  the  Aldrich  plan  was  calculated 
to  give  aid  chiefly  to  those  banl^s  that  were  engaged  in 
bond  jobbing  and  speculative  operations  and  which  held 
securities  whose  values  they  desired  to  "boom."  The 
opposition  betw^een  the  two  plans  seemed  to  be  irrecon- 
cilable. Finally  the  House  party  organization  headed  by 
the  speaker  put  forward  a  new  bill  knowTi  as  the  "Vree- 
land  bill ' '  from  the  name  of  its  putative  author,  in  which 
provision  was  made  for  the  issue  of  currency  by  organi- 
zations of  banks  upon  their  joint  responsibility.  This 
was  at  first  spoken  of  as  a  "clearing-house  currency 
bill"  and  the  organizations  were  referred  to  as  "clear- 
ing houses"  although  they  had  none  of  the  functions  of 
genuine  clearing  houses.  A  modified  bill  of  this  sort  was 
put  through  the  House  and  then  went  to  the  Senate, 
where  it  was  combined  with  the  Aldrich  bill  and  then 
passed  by  both  Houses. 

In  its  final  shape,  the  Act  provided  that  any  bank  might 


238  American  Banking 

deposit  with  the  Treasury  state,  municipal,  or  county 
bonds  up  to  a  specified  amount,  provided  it  had  already 
taken  out  national  bank  notes  based  on  government  bonds 
to  an  amount  equal  to  40  per  cent  of  their  capital.  The 
total  issue  of  notes  in  the  case  of  any  bank,  including  both 
the  old  and  new  kinds  of  notes,  was  not  to  exceed  the 
capital  and  surplus  of  the  bank.  *' National  currency 
associations"  might  also  be  organized  by  any  number  of 
banks  not  less  than  ten  which  had  a  combined  capital  of 
not  less  than  $5,000,000.  These  associations  might  accept 
from  their  members  any  securities,  including  commercial 
paper  (the  latter  to  be  used  to  an  amount  not  in  excess 
of  30  per  cent  of  the  capital  and  surplus  of  the  issuing 
bank)  and  might  then  make  application  to  the  Secretary 
of  the  Treasury  for  notes  which  could  be  issued  to  75 
per  cent  of  the  cash  value  of  the  commercial  paper.  Such 
notes  were  to  be  jointly  a  liability  upon  the  banks  in  the 
national  currency  association. 

A  great  deal  of  work  was  entrusted  to  the  Secretary  of 
the  Treasury  in  connection  with  the  detailed  organization 
of  the  currency  associations.  He  prepared  regulations 
governing  them,  but  the  conditions  were  too  onerous  to 
tempt  banks  to  enter  the  associations  and  consequently 
only  one  was  organized,  no  notes  being  taken  out  either 
directly  through  the  deposit  of  outside  bonds  with  the 
Treasury  or  indirectly  through  a  national  currency  asso- 
ciation. 

TEST  QUESTIONS 

1.  When  did  the  National  Bank  Act  go  into  effect? 

2.  What  were  the  circumstances  that  led  up  to  its  enactment? 

3.  Wliat  were  the  antecedents  of  the  National  Bank  Act  ? 

4.  What  provisions  did  the  act  make  for  absorbing  United 
States  bonds? 


National  Bank  Act  239 

5.  Explain  the  early  difficulties  encountered  in  securing  an 
equitable  territorial  distribution  of  national  bank  notes  and  the 
provisions  for  relief  adopted  by  the  government. 

6.  Explain  the  "double-profit"  charge  made  against  national 
banks  as  a  result  of  the  note-issue  privilege. 

7.  How  did  the  growth  of  the  government  surplus  during  the 
years  1881-91  affect  note  circulation?     Why? 

8.  What  were  some  of  the  outstanding  shortcomings  of  the 
National  Bank  Act  as  revealed  in  the  experiences  of  1893-97? 

9.  What  changes  were  made  by  the  Act  of  1900? 

10.  What  was  the  occasion  of  the  currency  legislation  of  1908  ? 

11.  Explain  the  provisions  for  elasticity  of  currency  incor- 
porated in  that  law. 


CHAPTER  XVI 
the  federal  reserve  act 

History  of  the  Act 

There  was  no  serious  effort  at  further  legislation  until 
1912,  when  preparation  was  begun  in  the  House  of  Rep- 
resentatives for  the  presentation  of  a  new  measure. 
Without  at  present  entering  into  the  history  of  the  proc- 
ess by  which  the  measure  itself  was  framed,  between 
April,  1912,  and  June,  1913,  it  may  be  generally  said  that 
during  the  period  referred  to  a  preliminary  draft  of  what 
later  became  the  Federal  Reserve  Act  was  shaped  under 
the  auspices,  first  of  a  sub-committee  of  the  House  Bank- 
ing and  Currency  Committee  as  organized  in  the 
Sixty-Second  Congress,  Hon.  Carter  Glass  of  Virginia 
being  chairman  of  the  sub-committee  in  question,  and 
^then  under  the  auspices  of  Mr.  Glass  himself  as  the 
ranking  Democratic  member  and  prospective  chairman 
of  the  banking  and  currency  committee  to  be  organized 
in  the  House  of  Representatives  of  the  Sixty-Third  Con- 
gress. 

Upon  the  basis  of  careful  investigation,  conducted 
under  direction  and  supervision  of  the  committee,  partly 
at  public  hearings  during  the  winter  of  1912-1913,  partly 
by  private  investigations,  it  had  been  determined  what 
features  should  and  what  points  should  not  be  embodied 
in  the  proposed  measure.  The  bill  thus  drafted  had  been 
submitted  to  and  had  received  the  approval  of  President 
Woodrow  Wilson,  and  was  thus,  when  introduced  .in  the 

240 


Federal  Reserve  Act  241 

House  of  Representatives  on  June  18,  an  administration 
bill  in  the  sense  that  it  had  received  the  approval  of  those 
charged  with  administrative  responsibility,  while  it  had 
been  developed  by  the  authorized  legislative  agencies  of 
Congress. 

Essential  Featuees  of  Original  Bill 

As  thus  drafted  for  presentation,  the  banking  bill  cov- 
ered certain  main  points,  which  were  subjected  to  no 
serious  change  and  which  have  been  succinctly  reviewed 
in  a  report,  submitted  to  the  House  on  September  9, 1913, 
by  Chairman  Glass  on  behalf  of  the  Banking  and  Cur- 
rency Committee,  as  follows : 

After  looking  over  the  whole  ground,  and  after  examining  the 
various  suggestions  for  legislation,  some  of  which  have  just  been 
outlined,  the  Committee  on  Banking  and  Currency  is  firmly  of 
the  opinion  that  any  effective  legislation  on  banking  must  include 
the  following  fundamental  elements,  which  it  considers  indis- 
pensable in  any  measure  likely  to  prove  satisfactory  to  the 
country : 

1.  Creation  of  a  joint  mechanism  for  the  extension  of  credit 
to  banks  which  possess  sound  assets  and  which  desire  to  liquidate 
them  for  the  purpose  of  meeting  legitimate  commercial,  agricul- 
tural, and  industrial  demands  on  the  part  of  their  clientele. 

2.  Ultimate  retirement  of  the  present  bond-secured  currency, 
with  suitable  provision  for  the  fulfillment  of  government  obliga- 
tions to  bondholders,  coupled  with  the  creation  of  a  satisfactory 
flexible  currency  to  take  its  place. 

3.  Provision  for  better  extension  of  American  banking  facili- 
ties in  foreign  countries  to  the  end  that  our  trade  abroad  may 
be  enlarged  and  that  American  business  men  in  foreign  countries 
may  obtain  the  accommodations  they  require  in  the  conduct  of 
their  operations. 

Beyond  these  cardinal  and  simple  propositions  the  committee 
has  not  deemed  it  wise  at  this  time  to  make,any  recommendations, 


242  American  Banking 

save  that  in  a  few  particulars  it  has  suggested  the  amendment 
of  existing  provisions  in  the  National  Bank  Act,  with  a  view  to 
strengthening  that  measure  at  points  where  experience  has  shown 
the  necessity  of  alteration. 

In  order  to  meet  the  requirements  thus  sketched,  the  committee 
proposes  a  plan  for  the  organization  of  reserve  or  rediscount 
institutions  to  which  it  assigns  the  name  * '  federal  reserve  banks. ' ' 
It  recommends  that  these  be  established  in  suitable  places 
throughout  the  country  to  the  number  of  12  as  a  beginning, 
and  that  they  be  assigned  the  function  of  bankers*  banks.  Under  / 
the  committee 's  plan  these  banks  would  be  organized  by  existing  V 
banks,  both  national  and  state,  as  stockholders.  It  believes  that 
banking  institutions  which  desire  to  be  known  by  the  name 
"national"  should  be  required,  and  can  well  afford,  to  take  upon 
themselves  the  responsibilities  involved  in  joint  or  federated 
organization.  It  recommends  that  these  bankers'  banks  shall 
be  given  a  definite  capital,  to  be  subscribed  and  paid  by  their 
constituent  member  banks  which  hold  their  shares,  and  that 
they  shall  do  business  only  with  the  banks  aforesaid,  and  with 
the  government.  Public  funds,  it  recommends,  shall  be  deposited 
in  these  new  banks,  which  shall  thus  acquire  an  essentially  public 
character,  and  shall  be  subject  to  the  control  and  oversight  which 
is  a  necessary  concomitant  of  such  a  character.  In  order  that 
these  banks  may  be  effectively  inspected,  and  in  order  that  they 
may  pursTO  a  banking  policy  which  shall  be  uniform  and  har- 
monious for  the  country  as  a  whole,  the  committee  proposes  a 
general  board  of  management  intrusted  with  the  power  to  over- 
look and  direct  the  general  functions  of  the  banks  referred  to. 
To  this  it  assigns  the  title  of  "The  Federal  Reserve  Board."  It 
further  recommends  that  the  present  national  banks  shall  have 
their  bonds  now  held  as  security  for  circulation  paid  at  the  end 
of  20  years,  and  that  in  the  meantime  they  may  turn  in  these 
bonds  by  a  gradual  process,  receiving  in  exchange  3  per  cent 
bonds  without  the  circulation  privilege. 

In  lieu  of  the  notes,  now  secured  by  national  bonds  and 
issued  by  the  national  banks,  and,  so  far  as  necessary  in  addi- 
tion to  them,  the  committee  recommends  that  there  shall  be 


Federal  Reserve  Act  243 

an  issue  of  "federal  reserve  notes,"  to  be  the  obligations  of  the 
United  States,  but  to  be  paid  out  solely  through  federal  reserve 
banks  upon  the  application  of  the  latter,  protected  by  commercial 
paper,  and  with  redemption  assured  through  the  holding  of  a 
reserve  of  gold  amounting  to  33  Vs  per  cent  of  the  notes  out- 
standing at  any  one  time.  In  order  to  meet  the  requirements  of 
foreign  trade,  the  committee  recoinmends  that  the  power  to  estab- 
lish foreign  branch  banks  shall  be  bestowed  upon  existing  national 
banks  under  carefully  prescribed  conditions  and  that  federal 
reserve  banks  shall  also  be  authorized  to  establish  offices  abroad 
for  the  conduct  of  their  own  business  and  for  the  purpose  of. 
facilitating  the  fiscal  operations  of  the  United  States  Government. 
Finally  and  lastly,  the  committee  suggests  the  amendment  of 
the  National  Bank  Act  in  respect  to  two  or  three  essential  par- 
ticulars, the  chief  of  which  are  bauk  examinations,  the  present 
conditions  under  which  loans  are  made  to  farming  interests,  and 
the  liability  of  stockholders  of  failed  banks.  It  believes  that 
these  recommendations,  if  carried  out,  will  afford  the  basis  for 
the  complete  reconstruction  and  the  very  great  strengthening 
and  improvement  of  the  present  banking  and  credit  system  of 
the  United  States.  The  chief  evils  of  which  complaint  has  been 
made  will  be  rectified,  while  others  will  at  least  be  palliated  and 
put  in  the  way  of  later  elimination. 

The  federal  reserve  banks  suggested  by  the  committee  as  just 
indicated  would  be  in  effect  co-operative  institutions,  carried 
on  for  the  benefit  of  the  community  and  of  the  banks  themselves 
by  the  banks  acting  as  stockholders  therein.  It  is  proposed  that 
they  shall  have  an  active  capital  equal  to  10  per  cent  of  the 
capital  of  existing  banks  which  may  take  stock  in  the  new  enter- 
prise. This  would  result  in  a  capital  of  something  over  $100,000,- 
000  for  the  reserve  banks  taken  together  if  practically  all  existing 
national  banks  should  enter  the  system.  It  is  supposed,  for  a 
number  of  reasons,  that  the  banks  would  so  enter  the  system. 
More  will  be  said  on  this  point  later  in  the  discussion.  How 
many  state  banks  would  apply  for  and  be  granted  admission 
to  the  new  system  as  stockliolders  in  the  reserve  banks  cannot 
be  confidently  predicted.     It  may,  however,  be  fair  to  assume 


244  American  Banking 

•at  this  point  that  the  total  capital  of  the  reserve  banks  will  be 
in  the  neighborhood  of  $100,000,000.  The  bill  recommended  by 
the  committee  provides  for  the  transfer  of  the  present  funds  of 
the  government  included  in  what  is  known  as  the  general  fund 
to  the  new  federal  reserve  banks,  which  are  thereafter  to  act  as 
fiscal  agents  of  the  government.  The  total  amount  of  funds 
which  would  thus  be  transferred  cannot  now  be  predicted  with 
absolute  accuracy,  but  the  released  balance  in  the  general  fund 
of  the  Treasury  is  not  far  from  $135,000,000.  Certain  other 
funds  now  held  in  the  Department  would  in  the  course  of  time 
be  transferred  to  the  banks  in  this  same  way,  and  that  would 
result  in  placing,  according  to  the  estimates  of  good  authorities, 
an  ultimate  sum  of  from  $200,000,000  to  $250,000,000  in  the 
hands  of  the  reserve  banks.  If  the  former  amount  be  assumed 
to  be  correct,  it  is  seen  that  the  reserve  banks  would  start  shortly 
after  their  organization  with  a  cash  resource  of  at  least  $300,- 
000,000.  As  will  presently  be  seen  in  greater  detail,  it  is  proposed 
to  give  to  the  reserve  banks  reserves  now  held  by  individual 
banks  as  reserve  holders  under  the  National  Bank  Act  for  other 
banks.  Confining  attention  to  the  national  system,  it  is  probable 
that  the  transfer  of  funds  thus  to  be  made  by  the  end  of  a  year 
from  the  date  at  which  the  new  system  would  be  organized  would 
be  in  the  neighborhood  of  $350,000,000.  If  state  banks  entered 
the  system  and  conformed  to  the  same  reserve  requirements  they 
would  proportionately  increase  this  amount,  but  for  the  sake 
of  conservatism  the  discussion  may  be  properly  confined  to  the 
national  banks.  For  reasons  which  will  be  stated  at  a  later 
point,  it  seems  likely  that  at  least  $250,000,000  of  the  reserves 
just  referred  to  would  be  transferred  to  the  reserve  banks  in 
cash ;  and  if  this  were  done  the  total  amount  of  funds  which  they 
would  have  in  hand  would  be  at  least  $550,000,000.  This  would 
create  a  reservoir  of  liquid  funds  far  surpassing  anything  of 
similar  kind  ever  available  in  this  country  heretofore.  It  would 
compare  favorably  with  the  resources  possessed  by  government 
banking  institutions  abroad. 

It  will  be  observed  that  in  what  has  just  been  said  the  reserve 
banks  have  been  spoken  of  as  if  they  were  a  unit.    The  committee, 


Federal  Reserve  Act  245 

however,  reeoimnends  that  they  shall  be  individually  organized 
and  individually  controlled,  each  holding  the  fluid  funds  of  the 
region  in  which  it  is  organized  and  each  ordinarily  dependent 
upon  no  other  part  of  the  country  for  assistance.  The  only  factor 
of  centralization  which  has  been  provided  in  the  committee's 
^plan  is  found  in  the  Federal  Reserve  Board,  which  is  to  be  a 
strictly  government  organization  created  for  the  purpose  of 
inspecting  existing  banking  institutions  and  of  regulating  rela- 
tionships between  federal  reserve  banks  and  between  them  and 
the  government  itself.  Careful  study  of  the  elements  of  the 
problem  has  convinced  the  committee  that  every  element  of 
advantage  found  to  exist  in  co-operative  or  central  banks  abroad 
can  be  realized  by  the  degree  of  co-operation  which  will  be 
secured  through  the  reserve-bank  plan  recommended,  while  many 
dangers  and  possibilities  of  undue  control  of  the  resources  of  one 
section  by  another  will  be  avoided.  Local  control  of  banking, 
local  application  of  resources  to  necessities,  combined  with  fed- 
eral supervision,  and  limited  by  federal  authority  to  compel 
the  joint  application  of  bank  resources  to  the  relief  of  dangerous 
or  stringent  conditions  in  any  locality  are  the  characteristic  fea- 
tures of  the  plan  as  now  put  forward.  The  limitation  of  business 
which  is  proposed  in  the  sections  governing  rediscounts,  and  the 
maintenance  of  all  operations  upon  a  footing  of  relatively  short 
time  will  keep  the  assets  of  the  proposed  institutions  in  a  strictly 
fluid  and  available  condition,  and  will  insure  the  presence  of 
the  means  of  accommodation  when  banks  apply  for  loans  to 
enable  them  to  extend  to  their  clients  larger  degrees  of  assistance 
in  business.  It  is  proposed  that  the  government  shall  retain  a 
sufficient  power  over  the  reserve  banks  to  enable  it  to  exercise 
a  directing  authority  when  necessary  to  do  so,  but  that  it  shall 
in  no  way  attempt  to  carry  on  through  its  own  mechanism  the 
routine  operations  of  banking  which  require  detailed  knowledge 
of  local  and  individual  credit  and  which  determine  the  actual 
use  of  the  funds  of  the  community  in  any  given  instance.  In 
other  words,  the  reserve-bank  plan  retains  to  the  government 
power  over  the  exercise  of  the  liroader  banking  functions,  while 


L^ 


246  American  Banking 

it  leaves  to  individuals  and  privately  owned  institutions  the 
actual  direction  of  routine. 

Congressional  Action  on  the  Bill 

As  first  presented,  the  bill  was  taken  in  hand  by  the 
House  Committee  on  Banking  and  Currency,  which,  how- 
ever, had  not  been  named  until  a  few  days  previous  to 
the  introduction  of  the  measure.  The  committee  held  its 
first  meeting  on  June  6;  then  began  the  active  work  of 
considering  the  bill  on  July  7;  and  regular  sessions  of 
several  hours  each  day  continued  until  the  beginning  of 
September.  The  bill  was  then  reported  to  a  Democratic 
caucus,  and  after  about  two  weeks  of  discussion  behind 
closed  doors  was  ratified,  and  was  thereupon  formally 
reported,  on  September  9,  to  the  House  of  Representa- 
tives, where  it  was  taken  under  debate  on  September  10, 
and  ultimately  brought  to  a  passage  in  the  House  on  Sep- 
tember 18. 

It  was  then  sent  to  the  upper  chamber  and  was  taken 
under  advisement  in  the  Senate  Banking  Committee, 
where  extensive  hearings  were  promptly  begun  and  were 
continued  until  October  25.  Thereafter,  a  month  of  con- 
sideration in  committee  ensued,  and  subsequently  three 
days  of  caucus  consideration  in  the  Senate,  a  final  report 
to  the  Senate  as  such  being  rendered  on  December  1. 
Debate  then  began  and  was  continued,  first  in  the  inter- 
vals of  business  already  scheduled,  then  at  practically 
continuous  sessions  until  December  19,  when  a  final  vote 
was  secured  and  the  measure  within  twenty-four  hours 
sent  to  conference,  from  which  it  emerged  on  December 
22,  receiving,  as  already  stated,  the  President's  signature 
on  the  following  day. 

As  the  bill  ultimately  passed  the  Senate,  it  differed 
from  the  plan  of  the  House  in  no  respect  that  was  of 


Federal  Reserve  Act  247 

theoretical  importance.  It  retained  the  provision  for 
sales  of  stock  to  private  holders  and  for  the  voting 
of  the  stock  by  trustees  representing  these  holders,  as 
well  as  for  the  purchase  of  stock  by  the  United  States 
itself,  in  case  of  necessity  for  so  doing.  It,  moreover, 
introduced  a  change  in  the  method  of  distributing  the 
earnings  of  federal  reserve  banks  whereby  a  portion  of 
those  earnings  was  to  be  employed  for  establishing  a 
fund  for  guaranteeing  the  deposits  of  member  banks 
which  had  taken  stock  in  the  federal  reserve  banks  of 
their  district.  It  altered  the  number  of  banks  by  cutting 
it  to  not  less  than  8  and  not  more  than  12,  in  place  of 
the  *'at  least  12"  of  the  House  biU.  While  many  minor 
changes  and  alterations  of  wording  were  made  through- 
out, they  did  not  alter  the  essential  structure  of  the  plan, 
but  in  some  cases  carried  it  further  than  the  framers  of 
the  House  measure  had  been  able  to  do,  embodying  ideas 
that  had  been  urged  by  them  while  the  measure  was  under 
discussion,  but  for  which  they  had  not  succeeded  in 
obtaining  indorsement.  Perhaps  the  most  injurious  fea- 
tures which  were  added  during  the  Senate  stage  of  the 
measure  were  the  provision  cutting  reserves  of  member 
banks  to  too  low  a  point  and  that  permitting  the  intro- 
duction of  bank  notes  into  reserves  as  a  constituent 
element  therein. 

The  substance  of  the  work  done  in  conference  com- 
mittee may  be  summarized  somewhat  further  in  order 
to  bring  out  the  points  that  had  been  accepted  as  inno- 
vations upon  the  House  bill  and  those  that  had  been 
rejected  because  the  changes  proposed  in  them  were  not 
deemed  wise.  Turning  first  to  the  alterations  in  the 
House  bill  that  secured  acceptance,  we  may  enumerate 
the  principal  features  as  follows; 


248  American  Banking 

(1)  Introduction  of  provision  for  sale  of  stock  in  fed- 
eral reserve  banks  to  the  public  in  the  event  that  not 
enough  banks  subscribed  for  the  stock  to  furnish  an  ade- 
quate capital  in  any  given  district. 

(2)  Provision  for  alternative  voting  in  the  choice  of 
directors  of  federal  reserve  banks  so  as  to  insure  prompt 
election. 

(3)  Reduction  of  number  of  federal  reserve  banks  to 
not  more  than  12,  as  against  the  ''at  least  12"  of  the 
House  bill. 

(4)  Elimination  of  requirement  that  all  national  banks 
recharter. 

(5)  Broadening  of  powers  of  Federal  Reserve  Board 
and  modification  of  language  relating  to  rediscounts 
between  federal  reserve  banks,  so  as  to  render  such  redis- 
counts easier  than  was  intended  by  the  House  bill. 

(6)  Provision  that  the  Secretary  of  the  Treasury 
might,  not  must,  deposit  public  funds  in  reserve  banks. 

(7)  Reduction  of  reserve  requirements  placed  upon 
member  banks  under  House  bill. 

On  the  other  hand,  the  following  important  points  were 
yielded  by  the  Senate  in  the  conference : 

(1)  Omission  of  provision  that  holders  of  stock  sold 
to  private  individuals  (if  any)  should  have  voting  power 
in  directorates  of  federal  reserve  banks  and  elsewhere. 

(2)  Elimination  of  guarantee  of  bank  deposits,  by  use 
of  surplus  earnings. 

(3)  Elimination  of  provision  that  federal  reserve  bank 
notes  might  be  counted  in  reserves  of  stockholding  banks. 

(4)  Restoration  of  provision  that  many  classes  of 
checks  should  be  collected  at  par  throughout  the  country, 
and  that  where  such  par  collection  was  not  enforced  the 
chai'ge  for  making  collection  should  be  fixed  by  the  Fed- 
eral Reserve  Board. 


Federal  Reserve  Act  249 

(5)  Elimination  of  domestic  acceptances,  thereby 
excluding  them  from  use  by  stockholding  banks  and  from 
rediscount  by  federal  reserve  banks. 

(6)  Modification  of  reserve  requirements  as  formu- 
lated by  the  Senate  so  as  to  require  actual  cash  reserves 
in  the  vaults  of  country  banks  (the  Senate  having  entirely 
dispensed  with  such  reserves  after  twenty-four  months 
from  date  of  the  passage  of  the  act)  and  general  stiffen- 
ing of  reserve  requirements  made  by  the  Senate,  although 
the  final  language  still  constituted  a  reduction  below  the 
House  provision. 

(7)  Reduction  of  period  of  maturity  for  which  dis- 
countable paper  might  run. 

\Vhile  many  other  points  of  modification  and  conces- 
sions on  either  side  might,  of  course,  be  enumerated,  it 
is  believed  that  the  foregoing  presentation  is  representa- 
tive and  shows  sufficiently  well  the  nature  of  the  confer- 
ence work  and  the  character  of  the  points  conceded  on 
either  side.  Assuming  that  such  a  fair  or  representative 
selection  has  been  made,  it  is  evident  that  the  w^ork  of 
the  conference  resulted  in  the  establishment  of  the  House 
contentions  at  nearly  every  essential  point,  the  excep- 
tions to  such  a  remark  being  found  in  two  main 
particulars : 

(1)  The  reduction  in  the  number  of  reserve  banks  and 
their  limitation  to  not  more  than  12  at  any  time. 

(2)  The  provision  that  public  deposits  might  or  might 
not  be  made  in  the  reserve  banks  at  the  discretion  of  the 
Secretary  of  the  Treasury. 

While  other  points  were  significant  and  important  in 
their  way,  it  can  certainly  be  fairly  concluded  that  on 
those  matters  involvdng  important  issues  of  theory  the 
House  virtually  held  its  own  in  most  respects.    In  fact, 


250  American  Banking 

it  is  an  accurate  generalization  that  the  final  bill  as  com- 
pleted in  conference  committee  and  as  passed  by  both 
houses  was  a  closer  approach  to  the  original  House  draft 
of  the  measure  than  anything  that  had  intervened  during 
the  time  the  bill  was  going  through  the  various  permuta- 
tions to  which  it  was  subjected  in  its  slow  progress  from 
one  stage  to  another  of  the  legislative  process. 

At  one  other  point  there  was  marked  and  vital  depart- 
ure from  the  original  House  measure — the  provision  with 
reference  to  the  refunding  of  United  States  2  per  cent 
bonds  and  the  treatment  of  the  currency  based  upon 
such  bonds.  On  this  subject  the  final  action  of  the  con- 
ference was  nearly  equivalent  to  the  acceptance  of  a  plan 
formulated  by  the  administration  and  designed  to  take 
the  place  of  all  the  various  other  schemes  that  had  been 
recommended  from  different  sources  in  either  House. 

Sources  of  the  Bill 

The  Federal  Eeserve  Act  is  the  product  of  a  lengthy 
coufse  of  development  and  has  grown  gradually  out  of 
the  discussion  and  analysis  of  the  past  twenty  years.  It 
is  not  dra^vn,  even  largely,  from  any  single  source,  but 
is  the  product  of  comparison,  selection,  and  refinement 
upon  the  various  material,  ideas,  and  data,  rendered 
available  throughout  a  long  course  of  study  and  agita- 
tion. Many  bills  embodjdng  the  same  general  line  of 
thought  that  now  finds  expression  in  the  new  Act  have 
been  offered  in  Congress ;  some  have  been  suggested  out- 
side that  body.  The  most  fundamental  concept  of  all 
— that  of  uniting  the  banks  of  the  country  into  organized 
groups — is  found  in  the  clearing-house  organizations, 
w^hich  in  times  of  stress  have  pooled  their  resources  and 
converted  bank  assets  into  the  equivalent  of  reserve 
money.    The  bills  prepared  by  or  under  the  direction  of 


Federal  Reserve  Act  251 

Hon.  Isidor  Straus,  Hon.  J.  H.  Walker,  Hon.  Charles  A. 
Fowler,  and  Hon.  Maurice  L.  Mulileman  have  supplied  at 
least  the  basis  for  many  of  the  detailed  analyses  and 
methods  of  treatment  that  are  found  in  the  Federal 
Reserve  Act.  Earlier  than  any  of  these  was  the  bill 
recommended  by  the  Indianapolis  Monetary  Commission, 
which  did  not  provide  for  co-operative  unions  of  banks, 
but  upon  which  the  framers  of  the  present  act  have  evi- 
dently drawn  for  some  of  their  ideas. 

The  latest  bill  in  the  long  series  which  was  available 
for  study  to  the  framers  of  the  Federal  Reserve  Act, 
was  that  prepared  for  the  National  Monetary  Commis- 
sion and  called  in  popular  language  the  ''Aldrich  bill." 
By  many  the  new  law  is  regarded  as  a  partial  copy  of, 
or  plagiarism  from,  the  Aldrich  bill;  and  that  view  has 
been  widely  expressed  both  in  and  out  of  Congress.  The 
Aldrich  bill  provided  for  a  single  central  ''reserve  asso- 
ciation" with  scanty  public  oversight,  with  practically 
all  control  vested  in  the  banks,  and  with  the  preponder- 
ance of  power  in  hands  of  the  larger  institutions  which 
owned  stock.  It  so  arranged  things  as  to  keep  this 
''reserve  association"  relatively  inactive  except  upon 
special  occasions  of  panic  or  disturbance.  It  made  no 
direct  provision  for  the  shifting  of  reserves  in  part  from 
existing  banks  to  the  proposed  associations,  but  it  relied 
upon  inflation  due  to  the  placing  of  bank  notes  issued  by 
the  central  association  in  the  reserves  of  the  stockholding 
banlis  for  protection  in  time  of  danger. 

The  new  act  provides  for  from  8  to  12  reserve  banks, 
introduces  the  principle  of  local  control,  calls  for  strict 
government  oversight,  shifts  reserves  from  present  cor- 
respondent banks  to  the  new  institutions,  minimizes  the 
influence  of  the  larger  banks  in  directorates,  and  gener- 
ally diffuses  control  instead  of  centralizing  it.    It  leaves 


252  American  Banking 

banking  as  such  to  be  practiced  by  bankers ;  it  vests  the 
control  of  banking  in  the  hands  of  government  officers. 
The  theory  and  purpose  of  the  new  act  are  widely  dif- 
ferent from  those  of  the  Aldrich  bill.  Where  the  Aldrich 
proposal  veers  ^^4dely  away  from  the  tendencies  that 
have  been  developed  during  the  preceding  ten  years  of 
American  banking  discussion,  the  Federal  Reserve  Act 
closely  follows  them.  Indeed,  the  Act  of  1913  is  closer  to 
any  one  of  half  a  dozen  bills  of  former  years  than  to  the 
Aldrich  proposal. 

From  the  standpoint  of  technique,  as  already  noted, 
the  case  is  quite  different.  With  regard  to  stock  issues, 
kinds  of  paper  eligible  for  rediscounts,  and  not  a  few 
other  particulars,  the  Federal  Reserve  Act  follows  lines 
laid  down  in  the  measure  which  bore  the  name  of  Senator 
Aldrich.  In  fact,  the  original  House  bill,  for  strategic 
purposes,  retained  wherever  it  could  safely  do  so  the 
language  of  the  Aldrich  bill  as  regards  banking  technique, 
its  framers  recognizing  that  by  so  doing  they  enormously 
reduced  the  hold  of  the  opposition  and  immensely  con- 
tracted the  field  within  which  the  familiar  charges  of 
"unsoundness"  could  find  scope. 

Perhaps  the  most  notable  and  beneficial  changes  made 
by  the  Federal  Reserve  Act — the  transfer  of  reserves 
from  reserve  to  central  reseiwe  city  banks  and  the  pro- 
visions for  par  collection  of  diecks  whenever  possible — 
were  not  mentioned  either  in  the  Aldrich  bill  or  in  those 
of  its  predecessors  already  referred  to.  They  were  not 
only  new  elements  in  the  movement  but  were  undoubtedly 
among  the  elements  in  the  measure  which  proved  hardest 
to  enact  into  law.  From  the  beginning,  the  most  strenu- 
ous opposition  was  offered  to  them,  notwithstanding  that 
both  features  were  admitted  to  be  sound  in  principle.  It 
was,  therefore,  only  after  a  sharp  contest  that  they  sue- 


Federal  Reserve  Act  253 

ceeded  in  gaining  a  definite  foothold,  inasmuch  as  they 
constituted  a  new  and  distinctly  distasteful  element  in 
the  whole  legislative  proposal. 

A  review  of  the  detailed  provisions  of  the  measure 
shows,  therefore,  that,  while  the  conception  of  banking 
reform  upon  which  it  is  founded  is  the  same  that  has 
constituted  the  staple  of  the  banking  reform  movement 
of  recent  years,  and  while  the  conception  of  a  union  of 
banks  is  directly  borrowed,  as  in  other  bills  of  the  past 
decade,  from  the  actual  practice  of  the  banks  themselves 
as  developed  under  the  stress  of  circumstances  in  the 
form  of  clearing-house  organizations;  while,  moreover, 
certain  phases  of  the  technique  of  the  legislation  itself 
followed  the  lines  of  the  Aldrich  or  Monetary  Commis- 
sion bill,  and  while  other  portions  of  the  Act  have  been 
adapted  from  well-known  legislative  proposals  that  have 
figured  within  the  past  few  years  of  banking  discussion, 
the  Act  as  a  whole  is  based  upon  a  conception  and  plan 
entirely  its  own,  applies  in  many  fundamental  respects 
methods  of  control  and  administration  that  have  been 
given  at  least  a  new  form,  and  includes  several  important 
innovations,  not  heretofore  conspicuous  in  banking  dis- 
cussion although  admittedly  significant,  not  to  say 
necessary  to  any  thorough  reorganization  upon  sound 
principles.  That  the  Act  also  contains  some  elements 
that  may  be  regarded  as  reminiscences  of  the  less  desir- 
able and  more  objectionable  phases  of  banking  agitation, 
is  equally  certain.  These  are  seen  in  the  underlying 
concept  of  the  federal  reserve  notes,  which  are  thought 
of  as  government  currency  loaned  to  banks,  and  are  thus 
at  least  theoretically,  although  not  practically,  in  line 
with  so-called  ''government  currency"  schemes  of  past 
years.  Fundamentally,  the  system  is  based  upon  experi- 
ence and  upon  proved  workable  principles. 


254  American  Banking 

TEST  QUESTIONS 

1.  "What  were  the  three  primary  aims  of  the  banking  legislation 
of  1913  as  summarized  by  Chairman  Glass? 

2.  What  were  the  recommendations  of  the  House  Committee 
on  Banking  and  Currency  in  regard  to  the  kind  of  currency  to 
be  created  by  the  act? 

3.  What  Senate  amendments  to  the  House  bill  were  finally 
adopted?     In  what  respects  did  they  modify  the  original  bill? 

4.  What  important  points  were  yielded  by  the  Senate? 

5.  What  are  the  main  sources  of  the  Federal  Reserve  Act? 

6.  How  does  the  Federal  Reserve  Act  differ  from  the  Aldrich 
bill? 

7.  What  provisions  in  the  Federal  Reserve  Act  are  new  in  the 
sense  that  they  were  not  incorporated  in  any  previous  proposals  ? 


CHAPTER  XVII 
controi.  of  the  federal  reserve  system 

The  Federal,  Reserve  Board 

Governmental  supervision  of  banking  is  everywhere 
today  accepted  as  a  public  necessity.  Under  the  old 
National  Bank  Act  it  was  furnished  by  the  comptroller 
of  the  currency.  Under  the  Federal  Reserve  Act  a  new 
mechanism  for  it  is  supplied  by  the  Federal  Reserve 
Board.  "  ^  * 

The  Federal  Reserve  Board  is  the' central  controlling 
and  directing  mechanism  of  the  federal  reserve  system 
and,  therefore,  of  the  banking  system  of  the  United 
States.  Under  the  terms  of  the  Act  it  is  appointed  ^by 
the  president,  by  and  with  the  advice  and  consent  of  the 
Senate,  subject  to  the  following  limitations : 

1.  No  two  members  of  the  Board  can  be  chosen  from 
the  same  district.  ^ 

2.  Each  member  must  have  been  a  bona  fide  resident 
of  the  district  from  which  he  is  appointed  for  two  years 
preceding  his  appointment. 

3.  Two  members  of  the  Board  must  be  men  of  practical 
experience  in  banking  and  finance. 

Subject  to  these  limitations,  the  president,  with  the 
confirmation  of  the  Senate,  appoints  five  persons  of  his 
own  selection.  These,  together  with  the  comptroller  of 
the  currency  and  the  Secretary  of  the  Treasurj^,  make  up 
the  Federal  Reserve  Board.  The  Secretary  of  the  Treas- 
ury is  ex-officio  chairman  of  the  Board,  but  the  Board 

255 


256  American  Banking 

has  always  a  chief  executive  officer,  known  as  the  gover- 
nor, and  a  second  executive,  similarly  named,  and  known 
as  the  vice  governor.  The  Board  has  power  to  adopt  its 
own  by-laws,  rules  of  operation,  and  the  like,  and  to 
select  its  own  place  of  meeting. 

Its  functions  are  lengthy  and  detailed,  but  they  may 
be  briefly  summarized  under  the  following  main  heads : 

1.  To  select  government  directors  in  federal  reserve 
banks  and  to  approve  or  disapprove  the  salaries  of 
officers  of  the  banks. 

2.  To  establish  rules  and  regulations  for  the  manage- 
ment of  business  in  the  several  districts. 

3.  To  review  the  rate  of  discount  at  federal  reserve 
banks  and  to  originate  the  rate  of  rediscount  between 
federal  reserve  banks. 

4.  To  regulate  the  reserve  holdings  of  the  several 
banks  and  to  impose  p-enalties  or  fines  upon  those  banks 
that  permit  their  reserves  to  fall  below  the  specified  limit. 

The  permanent  and  regular  duties  of  the  Federal 
Reserve  Board  outlined  above  may  be  considered  under 
three  general  divisions : 

(1)  Administrative. 

(2)  Constructive. 

(3)  Educative. 

Administrative  Duties 

Administrative  functions  are  essentially  of  two  kinds : 

(a)  The  regular  and  recurring  duties  necessary  to  the 
operation  of  the  system,  and 

(b)  The  sporadic  or  occasional  duties  which  grow  out 
of  the  operation  of  the  Act,  but  which  do  not  occur  at 
any  definite  time  or  times. 

Of  the  regular  and  stated  duties  of  administration, 
probably   the   most   conspicuous    is   that    of   regularly 


Control  of  the  Reserve  System  257 

approving  discount  rates  when  tliey  are  submitted  by 
the  several  banks.  To  do  this  work  intelligently  involves 
careful  study  and  consideration  of  the  general  business 
conditions  throughout  the  nation,  of  the  situation  in 
each  of  the  reserve  districts  themselves,  and  of  the  broad 
general  outlook  for  the  future.  An  incidental  considera- 
tion is  necessarily  that  of  the  earnings  of  federal  reserve 
banks,  and  the  degree  in  which  it  is  necessary  or  desirable 
to  enlarge  those  earnings  through  the  taking  on  of  more 
business. 

Another  administrative  function  practically  continu- 
ous in  its  operation  is  that  of  granting  to  banks  power 
to  enlarge  their  acceptances  of  paper  up  to  100  per  cent  of 
their  capital  and  surplus,  and  of  extending  to  them  the 
right  to  exercise  the  functions  of  trustee,  executor, 
administrator,  and  the  like.  Under  the  terms  of  the 
Federal  Reserve  Act  these  powers  can  not  be  conveyed 
except  by  special  permit,  and  any  member  bank  which 
desires  to  make  use  of  them,  must,  therefore,  obtain  the 
consent  of  the  Board.  Under  the  system  which  has  been 
laid  down  by  the  Board  this  involves  an  application  first 
of  all  to  a  local  federal  reserve  bank,  and  when  such  an 
application  has  been  approved,  the  Board  is  in  position 
to  take  action,  either  confirming  or  disapproving  the 
[findings  of  the  federal  reserve  bank  which  had  passed 
upon  it. 

The  law  requires  also  that  each  federal  reserve  bank 
shall  submit  to  the  Federal  Reserve  Board  statements  of 
compensation  paid  to  officers  and  directors  that  they  may 
be  approved  by  the  Board.  This  naturally  implies  a 
study  of  proper  rates  of  compensation,  and  the  taking  of 
action  designed  to  fix  such  rates  when  occasion  demands. 
Once  established,  the  salary  lists  of  the  federal  reserve 
banks  are  not  likely  to  show  extensive  changes,  but  such 


258  American  Banking 

alterations  as  there  are  will  recur  and  require  attention 
from  time  to  time. 

Other  administrative  duties  must  likewise  be  per- 
formed, among  them  the  passing  upon  and  approval  of 
applications  for  and  surrender  of  capital  stock  in  federal 
reserve  banks,  the  holdings  of  the  member  banks  varying 
according  as  their  o^\ti  capitals  and  surpluses  increase 
and  decrease.  These,  however,  are  for  the  most  part 
technical,  and  no  further  enumeration  is  necessary. 

CONSTBUCTIVE   DuTIES 

The  constructive  duties  of  the  Board  prescribed  by 
law  are  seen  to  best  advantage  in  the  provision  which 
calls  for  the  development  and  application  of  regulations 
designed  to  control  methods  of  business.  Since  the  Board 
was  organized  it  has  issued  regulations  defining  com- 
mercial paper  eligible  for  discount,  regulations  relating 
to  the  definition  of  savings  accounts,  rules  for  the  issue 
and  retirement  of  capital  stock,  rules  for  the  purchase 
of  warrants  and  bankers'  acceptances  in  the  open  market, 
and  a  variety  of  others. 

These  regulations  govern  the  practices  of  the  federal 
reserve  banks,  and  have  substantially  the  force  of  law, 
inasmuch  as  the  Federal  Reserve  Act  itself  calls  for  the 
exercise  of  these  functions  subject  to  the  rules  made  by 
the  Board.  Inasmuch  as  the  character  of  the  rules  and 
regulations  thus  made  may  gradually  alter  the  scope  and 
methods  of  business  done  by  the  banks,  it  is  clear  that 
the  work  of  the  Board  in  this  regard  is  in  the  highest 
degree  constructive  in  its  nature.  At  times  it  is  almost 
equal  to  the  extensive  limitation  or  modification  of  the 
provisions  of  the  law  itself. 

It  is  difficult  to  say  how  far,  when  the  system  is  fully 
perfected,  it  will  be  necessary  for  the  Board  to  work  on 


Control  of  the  Reserve  System  259 

such  regulations.  A  reasonable  expectation  would  seem 
to  be  that  after  the  lapse  of  a  moderate  period  of  time, 
the  banks  would  become  fully  possessed  of  their  reserve 
holdings,  while  their  experience  would  also  have  demon- 
strated the  lines  along  which  they  must  work  in  the 
performance  of  their  business.  When  such  experience 
has  been  accumulated,  and  the  system  has  definitely  been 
set  in  working  order,  it  may  be  expected  that  the  regula- 
tions of  the  Board  will  be  changed  but  little,  and  that  any 
modifications  will  be  the  outcome  of  observation  and 
experience  of  banking  and  business  conditions  throughout 
the  nation.  By  changes  in  the  discount  rate,  the  volume 
of  business  will  be  controlled ;  but  the  methods  of  business 
at  the  banks,  which  are  dependent  upon  the  regulations 
aforesaid,  will  not  be  greatly  altered.  At  present  the 
federal  reserve  system  is  still  in  process  of  develop- 
ment, and  its  business  practices  are  being  worked  out. 
This  has  necessitated  more  or  less  frequent  changes  in 
regulations,  but  such  changes,  as  already  indicated,  will 
diminish  in  number  as  time  goes  on. 

The  Act  has  also  placed  in  the  hands  of  the  Federal 
Eeserve  Board  the  power  of  changing  and  readjusting 
>  the  reserve  districts,  subject  to  the  broad  general  require- 
ments that  there  should  not  be  less  than  eight  nor  more 
than  twelve.  How  extensive  such  readjustments  of  the 
districts  will  be,  experience  must  show;  and  when  the 
time  comes  to  make  them,  an  important  constructive 
function  of  the  Board  will  be  that  of  determining  when 
and  how  they  shall  be  introduced.  Already  the  Board 
has  granted  a  few  petitions  for  readjustment  of  boundary 
lines  between  districts. 

Of  the  same  general  character  is  the  provision  of  the 
Act  which  calls  for  the  establishment  of  branches,  and 
which  practically  invests  the  Board  with  the  authority 


260  American  Banking 

to  oversee  the  establishment  of  such  branches  of  federal 
reserve  banks.  Plainly  the  operation  of  the  law  in  this 
particular  will  mean  that  the  broadest  use  and  develop- 
ment of  the  system  and  its  branches,  the  establislmient 
of  agencies  abroad,  and  other  functions  of  the  same  gen- 
eral description,  will  be  intrusted  to  the  Board,  and  will 
constitute  one  of  its  most  important  duties  of  a  con- 
structive nature. 

Educatr'e  Functions 

Among  the  implied  or  educative  duties  of  the  Board 
is  undoubtedly  that  of  bringing  about  general  and  har- 
monious action  among  the  several  districts  and  of  welding 
the  different  parts  into  a  consistent,  united  whole.  In 
order  to  do  its  work  well,  the  Board  must  necessarily  be 
in  close  touch  with  the  several  districts  and  know  what 
is  going  on  in  them,  and  with  this  purpose  in  view,  direct 
communication  with  the  different  districts  has  been 
intrusted  to  the  several  members  of  the  Board  in  order 
that  they  may  keep  themselves  and  their  colleagues 
advised  of  any  developments  in  these  districts  which  call 
for  special  attention. 

An  annual  report  to  Congress  was  required  by  law 
and  must  be  formulated  by  the  Board.  It  was  also 
intrusted  with  the  duty  of  keeping  the  country  advised 
of  the  condition  of  the  system.  It  has  undertaken  to 
carrj^  out  this  duty  in  part  by  the  establishment  of  a 
publication  known  as  the  Federal  Reserve  Bulletin  in 
which  are  collected  notices  and  statements  about  the 
work  undertaken  and  the  results  accomplished  in  the 
operation  of  the  system.  Much  more  might  be  said  of 
the  detailed  work  of  the  Board  in  the  task  of  educating 
the  public  to  a  knowledge  of  its  operations  and  of  stand- 
ardizing banking  practices,  but  the  statements  already 


Control  of  the  Reserve  System  261 

made  practically  cover  the  ground  in  its  most  essential 
aspects. 

Organization  of  the  Board 

The  Federal  Reserve  Act  imposes  practically  no  limita- 
tions upon  the  methods  by  which  the  Board  performs  its 
own  work.  In  accordance  with  the  provision  of  the  law 
which  authorizes  the  Secretary  of  the  Treasury  to  provide 
quarters  for  the  Board  in  his  Department,  the  main 
offices  at  Washington  have  been  located  in  the  Treasury 
Building.  While  there  is  no  rigid  practice,  it  has  been 
customary  to  hold  meetings  from  three  to  five  times  a 
week,  usually  each  day,  although  during  the  period  of 
organization  two  meetings  a  day  were  not  uncommon. 

A  set  of  by-laws  defining  the  organization  of  the  Board 
was  early  adopted,  and  these  provide  for  an  Executive 
Committee  whose  function  it  is  to  transact  all  necessary 
business  not  involving  any  new  departures  of  policy. 
When  the  members  of  the  Board  are  practically  all 
present  in  Washington,  stated  meetings  on  Monday, 
Wednesday,  and  Friday,  with  Executive  Committee  meet- 
ings on  Tuesday  and  Thursday,  are  the  rule,  while  other 
committees  may  meet  occasionally  as  convenience  dic- 
tates. Sessions  of  the  Board  are  held  in  private,  and 
thus  far  no  public  sessions,  with  the  exception  of  the 
hearings  on  appeals  from  decisions  of  the  Reserve  Bank 
Organization  Committee,  have  been  appointed. 

When  a  decision  has  been  arrived  at  with  reference  to 
a  proposed  change  in  the  discount  rate,  or  the  adoption 
of  any  new  policy  or  method  of  business,  the  federal 
reserve  agents  are  at  once  advised  by  telegraph  or  letter, 
and  then  the  decision  is  communicated  to  the  various 
federal  reserve  banks.  The  federal  reserve  agent  is 
regarded   by  the   Board   as   its   representative   on   the 


262  American  Banking 

ground,  and,  as  such,  the  official  medium  of  communica- 
tion between  it  and  the  bank  to  which  he  is  accredited ; 
although  the  Board  may,  and  frequently  does,  hold  direct 
communication  ^\\i\l  the  governor  of  the  federal  reserve 
bank  as  being  the  active  operating  officer. 

COMPTEOLLEK    OF    THE    CURRENCY 

The  comptroller  of  the  currency  is  a  member  of  the 
Federal  Reserve  Board.  The  Federal  Reserve  Act  did 
not  change  his  previous  function  as  chief  of  the  national 
banking  sj^stem,  or  his  responsibility  to  the  Secretaiy  of 
the  Treasury  and  to  Congress.  These  relationships, 
therefore,  continue,  and  his  presence  on  the  Board  simply 
serves  to  establish  a  connecting  link  between  the  super- 
vision of  the  national  banking  system  as  such,  and  the 
general  supervision  of  the  federal  reserve  system,  includ- 
ing federal  reserve  banks  and  such  non-national  banks 
as  may  have  become  members. 

Secretary  of  the  Treasury 

In  the  same  way  the  Secretary  of  the  Treasury's 
membership  in  the  Board  in  no  way  alters  his  other 
relationships  or  duties.  The  fact  that  he  presides  over 
the  Board  enables  him  to  communicate  to  it  necessary 
information  with  reference  to  the  policies  of  the  Treasury 
Department  on  financial  and  banking  questions,  and  to 
receive  from  it  advice  and  information  concerning  the 
work  of  the  reserve  system. 

Under  the  Federal  Reserve  Act  the  placing  of  public 
deposits  in  the  reserve  banks  is  left  entirely  in  the  hands 
of  the  Secretary  of  the  Treasury,  although  the  Act  dis- 
tinctly contemplates  that  such  deposits  shall  be  made  and 
that  the  reserve  banks  shall  ultimately  assume  that  func- 
tion as  agents  of  the  Government.    AVhen  that  step  shall 


Control  of  the  Reserve  System  263 

have  been  taken,  the  membership  of  the  Secretary  of  the 
Treasury  on  the  Federal  Reserve  Board  will  have  an 
increasingly  direct  practical  importance  by  creating  an 
effective  communication  between  the  revenue  depart- 
ment of  the  United  States  Government  and  the  banks 
as  holders  of  the  funds.  The  membership  of  the  Secre- 
tary of  the  Treasury  in  the  Federal  Reserve  Board  will, 
under  those  conditions,  be  much  more  than  merely  for- 
mal, and  will  include  much  more  than  the  mere  rendering 
of  advice  and  suggestions.  It  will  of  necessity  be  a  prac- 
tical working  participation  on  the  part  of  the  Secretary 
of  the  Treasury  in  the  affairs  of  the  Board  and,  con- 
versely, a  participation  on  the  part  of  the  Board  as  a 
conservator  of  the  banking  resources  of  the  country  in 
the  operation  of  one  set  of  the  activities  of  tlie  Treasury 
Department. 

Bureau  of  Audit  and  Examination 

In  organizing  its  staff  at  Washington  for  the  per- 
formance of  the  duties  already  enumerated  and  others 
incidental  to  them,  the  Federal  Reserve  Board  found  it 
desirable  to  recognize  several  distinct  divisions.  The 
task  of  examining  member  banks  (not  national)  and  of 
making  periodic  examinations  of  federal  reserve  banks, 
has  been  committed  to  a  distinct  bureau  or  division  known 
>as  the  Bureau  of  Audit  and  Examination,  headed  by  a 
chief  under  whom  is  organized  a  small  corps  of  exam- 
iners and  assistant  examiners.  The  task  of  examining 
the  twelve  federal  reserve  banks  would  not  in  itself  be 
a  heavy  one,  but  as  state  banks  enter  the  system,  the 
duty  of  ascertaining  whether  they  are  in  suitable  condi- 
tion for  admission,  and  of  making  sure  that  they  continue 
to  be  so,  will  involve  a  considerable  amount  of  labor. 


264  American  Banking 

Division  of  Eepoets  and  Statistics 

Another  of  the  main  divisions  into  which  the  Board's 
work  is  divided  is  that  of  Reports  and  Statistics.  When 
the  Federal  Reserve  Act  was  drawn,  provision  was  made 
for  a  weekly  report  of  the  condition  of  all  federal  reserve 
banks  and  of  each  bank,  showing  the  main  items  in  their 
accounts.  This  is  prepared  in  the  Division  of  Reports 
and  Statistics  from  data  which  are  weekly  telegraphed 
to  the  Board  and  are  combined  to  make  up  the  final  state- 
ments. Provision  was  also  made  when  the  federal 
reserve  banks  were  organized  for  regular  reports  by  the 
several  banks  of  paper  purchased,  with  name  of  pur- 
chaser, maturity,  rate,  etc.  Complete  lists  showing  all 
these  items  of  information,  and  giving  data  as  to  the 
daily  condition  of  the  several  banks,  are  daily  forwarded 
to  Washington  by  each  one  of  the  institutions.    It  is  the 

uty  of  the  Division  of  Reports  and  Statistics  to  combine 
and  analyze  them  and  to  prepare  the  result  of  the  study 
in  such  form  for  examination  by  members  of  the  Board 
as  will  aid  them  in  forming  conclusions  regarding  the 
business  of  member  banks,  as  indicating  necessary 
changes  in  rates  of  discount,  and  as  otherwise  determin- 
ing the  policy  to  bC' pursued  in  the  general  conduct  of  the 
banking  system. 

Division  of  Cleaeing 

In  the  Federal  Reserve  Act  it  was  specified  that  each 
federal  reserve  bank  might  act  as  a  clearing  house  for 
its  members,  but  that  the  Federal  Reserve  Board  might 
act  as  a  clearing  house  for  the  federal  reserve  banks,  or 
might  designate  one  of  the  federal  reserve  banks  thus 
to  act.  In  pursuance  of  this  authority,  the  Board  has 
.established  a  division  of  clearing  in  Washington  for  the 


Control  of  the  Rene  ire  System  265 

pui'pose  of  settling  balances  between  federal  reserve 
banks  without  the  actual  shipment  of  coin.  This  division 
is  in  charge  of  a  fund  of  about  $125,000,000  in  gold,  and 
conducts  a  set  of  books  on  which  are  recorded  from  week 
to  week  credits  and  debits  between  federal  reserve  banks 
arising  out  of  their  operations  during  the  week.  As  given 
banks  are  credited  or  debited  on  these  books,  the  amount 
of  their  ownership  in  the  Gold  Fund  changes. 

Supervision  of  Eeseeve  Banks 

Federal  reserve  banks  w^hich  are  under  special  obli- 
gations and  duties  are  not  only  closely  supervised  by,  but 
in  fact  operated  under,  close  government  supervision. 
Two  features  deserve  to  be  specially  noted  in  this 
connection : 

1.  Owing  to  its  close  relation  with  the  government 
each  federal  reserve  bank  has  a  special  officer  represent- 

'^'^  ing  the  government,  who  is  chairman  of  its  Board  of 
Directors  and  who  is  designated  as  ''federal  reserve 
agent. ' ' 

2.  Eveiy  federal  reserve  bank  confines  its  discount 
business  to  other  banks,  a  fact  which  at  once  alters  the 
type  of  organization  of  the  institution  in  some  important 
particulars. 

BOAED    OF    DiEECTOES 

The  fundamental  control  of  the  federal  reserve  bank 
is  in  the  hands  of  the  Board  of  Directors,  consisting  of 
nine  members.  This  Board  of  Directors  consists  of  three 
classes,  each  containing  three  members  and  each  class 
being  designated  by  a  letter,  as  A,  B,  and  C.  Class  C 
directors  are  nominated  by  and  represent  the  govern- 
ment. Class  B  directors  are  business  men  not  engaged 
in  banking  who  are  presumed  to  represent  in  a  general 


266  American  Banking 

way  the  industrial,  commercial,  and  agricultural  inter- 
ests of  the  district  in  which  the  bank  is  situated.  Class 
A  directors  are  directly  representative  of  the  banks. 

Both  Class  A  and  Class  B  directors  are  chosen  by  the 
banks,  and  for  the  purpose  of  this  selection,  the  banks 
in  each  district  are  divided  into  three  groups.  Group 
one  chooses  one  Class  A  and  one  Class  B  director, 
group  two  the  same  number,  and  group  three  the  same. 
In  group  one,  the  voters  or  electors  are  the  banks  of  large 
capitalization,  in  group  two  those  of  medium  capitaliza- 
tion, and  in  group  three  the  small  banks.  The  chairman 
of  each  board  of  directors  divides  the  banks  of  the  dis- 
trict into  these  three  groups  in  such  a  way  as  to  place 
an  approximately  equal  number  of  banks  in  each.  Each 
bank  has  one  vote,  irrespective  of  its  size.  The  group  } 
division,  however,  prevents  the  small  banks  from  elect- 
ing men  who  represent  them  exclusively  and  insures 
approximately  equal  representation  to  banks  of  some- 
what smaller  size.  The  directors  in  question  are 
appointed  for  equal  terms  of  three  years  each,  but  these 
terms  are  so  arranged  that  two  directors  go  out  of  office 
each  year,  thus  insuring  opportunity  for  rotation. 

The  chairman  of  the  Board  of  Directors  is  designated 
by  the  government  and  is  the  federal  reserve  agent  of 
the  bank.  A  vice  chairman,  with  the  title  of  deputy 
federal  reserve  agent,  is  also  designated  by  the  govern- 
ment. These  two  officers  are  of  the  number  of  Class  C 
directors.  The  remaining  Class  C  director,  sometimes 
described  as  the  ''unattached"  director,  has  no  specific 
functions  other  than  those  assigned  to  any  director  of 
the  bank. 

Fedeeal  Eeserve  Agent 

Eef erence  has  already  been  made  to  the  federal  reserve 
agent.     As   chairman   of  the   Board  of  Directors,  his 


Control  of  the  Reserve  System  267 

function  is  to  preside  over  meetings  of  tlie  Board,  and  in 
general  to  perform  all  those  functions  of  organization 
wliich  ordinarily  fall  to  the  chairman  of  a  deliberative 
body.  As  representative  of  the  government  in  his  capac- 
ity of  federal  reserve  agent  as  such,  he  connnunicates 
with  the  Federal  Reserve  Board  and  transmits  communi- 
cations from  that  body  to  the  bank.  He  also  acts  in  a 
fiduciary  capacity,  receiving  from  the  Board  at  Washing- 
ton the  notes  ready  for  circulation  in  such  amounts  as 
the  bank  deems  to  be  necessary,  and  issuing  or  trans- 
ferring these  to  the  bank  whenever  the  institution  has 
placed  with  him,  for  the  special  protection  of  such  notes, 
commercial  paper  of  the  kinds  specified  in  the  Federal 
Reserve  Act  as  eligible  for  rediscount.  It  is  his  duty 
to  report  regularly  to  the  Federal  Reserve  Board  upon 
prevailing  banking  and  commercial  conditions  in  his 
district  and  to  inform  the  Board  of  any  special  or  unusual 
conditions  demanding  attention  from  the  governing  body. 
An  important  function  which  falls  to  the  federal 
reserve  agent  is  that  of  advising  the  Board,  whenever 
necessary,  that  the  bank  desires  to  change  the  rate  of 
discount  on  commercial  paper.  If  such  application  for 
change  is  approved,  the  reserve  agent  notifies  his  bank 
and  announces  th«  rates  thus  newly  fixed  to  the  public. 
Beyond  these  definite  and  well-recognized  functions,  the 
duties  of  federal  reserve  agent  vary  somewhat  from  bank 
to  bank,  according  to  the  personality  of  the  agent  himself. 

The  Federal  Advisory  Council 

The  Federal  Reserve  Act  creates  an  Advisory  Council 
consisting  of  as  many  members  as  there  are  federal 
reserve  districts.  It  directs  the  Board  of  Directors  of 
each  federal  reserve  banlc  to  select  annually  from  its 
own  district  one  member  of  this  Council.    The  Council 


268  American  Banking 

shall  meet  at  least  four  times  a  year  at  Washington, 
D.  C,  and  of  tener  if  called  by  the  Federal  Reserve  Board. 
The  Council  at  its  o^vn  discretion  may  hold  additional 
meetings  at  Washington  or  elsewhere. 

The  Council  is,  as  its  name  implies,  simply  an  advisory 
body  which  confers  directly  mth  the  Federal  Reserve 
Board  on  general  business  conditions  and  may  call  for 
information  or  make  recommendations  concerning  fed- 
eral reserve  banking  operations  to  the  Federal  Reserve 
Board. 

TEST  QUESTIONS 

1.  In  what  body  is  the  administrative  control  of  the  federal 
reserve  system  lodged  ? 

2.  How  is  the  Federal  Reserve  Board  constituted? 

3.  "What  are  the  main  functions  and  powers  of  the  Federal 
Reserve  Board? 

4.  What  are  the  chief  administrative  duties  of  the  Board? 

5.  What  are  the  constructive  duties  of  the  Board  ?     Show  by 
a  concrete  example. 

6.  How  does  the  Board  exercise  its  educative  functions? 

7.  What  is  the  position  of  the  comptroller  of  the  currency  on 
the  Board?     The  Secretary  of  the  Treasury? 

8.  What  are  the  duties  of  the  Bureau  of  Audit  and  Exam- 
ination ? 

9.  What   are   the   duties   of   the   Division   of   Reports   and 
Statistics  ? 

10.  What  are  the  duties  of  the  Division  of  Clearing? 

11.  Explain  the  manner  in  which  federal  reserve  banks  are 
governed. 

12.  Explain  in  detail  how  the  directors  of  a  federal  reserve 
bank  are  chosen. 

13.  How  is  the  federal  reserve  agent  for  each  bank  appointed? 
What  are  his  duties? 

14.  Explain  the  organization  and  functions  of  the  Federal 
Advisory  Council. 


CHAPTER  XVni 

GOVERNMENT   FINANCES    AND    THE    RESERVE    SYSTEM 

For  many  years  past  the  essential  relations  between 
the  g-overnment  and  the  banks  have  been  a  matter  of 
public  discussion  and  controversy.  During  the  early  days 
immediately  after  the  founding  of  the  United  States,  the 
view  that  close  relations  should  be  maintained  between 
the  government  and  a  great  central  bank  which  should 
hold  the  public  funds,  receive,  and  disburse  them,  was 
the  accepted  theory.  It  was  on  this  basis  that  the  First 
Bank  of  the  United  States  was  founded.  There  was 
always  opposition  to  and  doubt  concerning  the  validity 
of  this  theory,  and  after  the  twenty-year  charter  granted 
by  the  govermnent  of  the  United  States  had  expired,  the 
government  went  back  to  the  plan  of  placing  its  funds 
with  the  many  small  banks  of  the  states.  This  proved 
unsatisfactory,  and  the  breakdown  of  the  system  was  in 
large  part  responsible  for  the  restoration  of  the  old 
method,  the  Second  Bank  of  the  United  States  being 
chartered  largely  for  the  purpose  of  handling  the  gov- 
ernment 's  finances. 

The    IlTDEPENDENT    TeEASUEY 

When  this  institution  had  been  dis-established  in  1837 
(owing  to  the  political  controversies  which  raged  around 
its  management),  the  old  unsatisfactory  plan  of  deposit- 
ing with  state  banks  was  resumed  and  was  found  to  be  as 
faulty  as  ever.    Heavy  losses  to  the  government  and  great 

269 


270  American  Banking 

inflation  ensued,  and  ultimately  the  so-called  ''independ- 
ent treasury  system"  was  brought  into  existence.  The 
theory  of  the  independent  treasury  system  has  been  that 
the  government  should  receive  only  actual  money,  and 
that  it  should  hold  such  money  in  strong  places  of  its  own, 
pajdng  out  actual  money  to  its  creditors. 

This  system  proved  imtenable  at  the  opening  of  the 
Civil  War  Avhen  a  paper  currency  issue  had  become  nec- 
essary. Not  only  did  the  sub-treasuries  have  to  receive 
the  government  legal-tender  notes,  but  they  shortly 
came  to  receive  national  bank  notes,  and  to  make  dis- 
bursements not  only  in  cash  but  in  paper.  Moreover, 
during  the  Civil  War  it  was  necessary  to  make  large  use 
of  banking  machinery,  and  the  system  was  soon  developed 
of  making  deposits  in  banks  with  special  protection  in 
the  form  of  government  bonds  deposited  with  the 
Treasury  of  the  United  States.  That  is  to  say,  if  the 
govermnent  needed  to  deposit  funds  in  banks  in  order  to 
obtain  banlving  facilities  in  transmitting  money,  or  for 
any  other  purpose,  it  was  v/ith  the  understanding  that 
the  bank  receiving  such  funds  would  place  an  equal 
amount  in  government  bonds  with  the  Treasury  of  the 
United  States  in  trust.  Then  if  the  depository  bank 
failed,  the  government  was  protected  because  it  held  an 
equal  amount  in  its  o^vn  bonds. 

The  independent  treasury  plan  as  thus  modified,  was 
never  satisfactory,  but  it  was  possible  to  operate  it 
without  serious  suffering  during  the  twenty  years  after 
the  close  of  the  Civil  War.  At  the  expiration  of  that 
length  of  time,  however,  new  conditions  had  developed. 
It  was  found  that  very  large  sums  of  money  tended  to 
accumulate  in  the  Treasury  because  the  system  of  taxa- 
tion produced  much  more  income  than  the  government 
was  disposed  at  that  time  to  expend.     The  alternative 


Government  Finances  and  Reserve  System      271 

was  thus  presented  of  either  keeping  the  actual  cash 
in  the  vaults  of  the  Treasury  inactive,  or  else  of  placing 
it  more  or  less  pennanently  on  deposit  with  the  banks. 
It  was,  of  course,  possible  to  use  some  portion  of  the 
funds  in  reducing  public  indebtedness  by  purchasing  such 
bonds  as  had  reached  their  maturity;  but  the  efforts 
that  were  made  in  this  direction  during  the  years  1880- 
1890  tended  to  raise  the  premium  on  government  bonds 
to  an  abnormal  figure,  so  that  it  was  soon  seen  that  there 
was  a  very  easily  reached  limit  to  such  operations. 

Even  at  that  comparatively  early  date  it  was,  more- 
over, recognized  that  as  the  national  banl^s  became  more 
numerous  and  consequently  required  more  and  more 
bonds  as  a  condition  of  their  organization  and  to  protect 
their  currency;  and  as  the  government's  surplus  depos- 
ited in  banks  became  larger  and  larger,  thus  requiring 
more  and  more  government  bonds  deposited  in  trust  to 
protect  it,  there  might  be  a  time  when  the  available  sup- 
ply of  government  bonds  would  be  exhausted,  and  when, 
consequently,  neither  expansion  of  bank  notes  nor 
enlargement  of  public  deposits  in  the  banks  would  be 
feasible. 

The  period  of  deficit  financiering  after  1890,  due  to 
the  tariff  legislation  of  that  year,  removed  all  further 
trouble  originating  with  the  Treasury  surplus,  and  it 
was  not  until  later  years  of  the  decade  of  1890-1900  that 
the  difficulty  again  became  serious.  After  1900  a  large 
surplus  again  developed,  and  as  in  former  years  it  was 
necessary  to  dispose  of  it  by  depositing  it  in  the  banks. 

The  withdrawal  of  so  much  money  from  circulation 
would  have  had  a  tendency  to  cramp  the  available 
fluid  resources  of  the  country,  and  to  limit  bank 
accommodation  by  a  corresponding  amount.  In  pursu- 
ance of  the  effort  to  distribute  the  surplus  funds  of  the 


272  American  Banking 

government  as  wisely  as  possible,  the  number  of  depos- 
itory banks  was  very  greatly  increased,  rising  at  one 
time — about  1904 — to  something  like  1,400.  The  deposits 
were  distributed  without  much  regard  to  the  legitimate 
claims  of  business,  and  largely  upon  the  basis  of  sectional 
or  other  favoritism. 

When  the  panic  of  1907  came  on,  the  surplus  funds  of 
the  government  were  very  widely  diffused ;  and  so  great 
a  quantity  of  bonds  had  been  absorbed  in  order  to  protect 
the  deposits  in  banks,  that  the  immediate  expansion  of 
the  national  bank-note  currency  to  meet  the  needs  of  the 
sudden  stringency  was  very  difficult.  This  experience 
emphasized  the  defects  of  the  independent  treasurj^  sys- 
tem, and  gave  point  to  the  belief  expressed  by  students 
of  the  situation  for  many  years  past  that  there  should 
be  an  entire  change  in  this  method  of  handling  public 
funds. 

Defects  of  the  Independent  Tbeasury  System 

The  harm  of  the  independent  treasury  plan  is  twofold ; 
the  system  is  not  wise  or  economical,  and  does  not  make 
use  of  well-known  modern  methods  in  handling  funds; 
it,  furthennore,  is  injurious  to  the  financial  structure  of 
the  country,  and  at  times  interferes  seriously  with  the 
ordinary  operations  of  business  and  finance. 

The  second  of  these  considerations  may  be  discussed 
first.  When  the  taxpayers  make  payment  to  the  govern- 
ment the  result  is  ultimately  to  transfer  to  tlie  Treasury 
an  equivalent  amount  of  actual  money.  This  money,  of 
course,  must  come  out  of  the  cash  which  is  in  circulation 
in  the  pockets  of  the  people ;  but  inasmuch  as  under  given 
circumstances  the  amount  needed  for  circulation  pur- 
poses is  practically  fixed,  the  funds  really  come  out  of 
the  vaults  of  the  banks,  and,  in  a  corresponding  degree, 


Ooverwiient  Finances  and  Reserve  System       273 

reduce  the  stock  of  money  in  the  banks.  By  reducing  the 
bank  reserves,  such  payments  to  the  government  conse- 
quently reduce  the  supply  of  loanable  funds  because  they 
limit  the  power  of  the  banks  to  lend  to  the  government 
in  exactly  the  proportion  that  the  reserves  required  of 
the  banks  bear  to  their  outstanding  obligations.  Thus, 
for  example,  if  at  any  given  time  a  bank  has  outstanding, 
say,  $6  or  $7  of  liabilities  for  every  $1  that  it  has  in  its 
v^aults,  the  withdrawal  of  $1  from  the  vaults  means  the 
probable  cancellation  of  $6  or  $7  in  credits.  The  with- 
drawal of  $100,000,000  from  the  vaults  of  the  bank  and 
its  payment  to  the  government  in  cash,  means  that 
$600,000,000  or  $700,000,000  of  possible  lending  power 
has  been  taken  from  the  bank. 

When  the  surplus  reaches  veiy  large  sums,  therefore, 
it  may  operate  to  reduce  the  stock  of  cash  available  for 
bank  reserves  in  a  very  material  degree.  The  surplus 
has  sometimes  for  long  periods  run  from  $200,000,000 
to  $250,000,000.  To  place  so  great  a  sum  in  the  vaults 
of  the  government  has  precisely  the  same  effect  as  if  the 
individual  had  hoarded  it.  The  money  so  withdrawn 
could  not  be  used  for  any  purpose.  Even  if  the  country, 
recognizing  the  probability  of  such  a  withdrawal,  pro- 
vided itself  with  the  money  it  needed  from  abroad,  it 
nevertheless  lost  the  interest  on  the  sums  so  tied  up  in 
the  vaults  of  the  government. 

The  real  trouble,  however,  resulted  from  the  fact  that 
the  public  could  not  anticipate,  as  a  rule,  such  a  with- 
drawal. It  could  not  predict  with  accuracy  the  conditions 
under  which  a  surplus  or  a  deficit  would  be  created. 
Frequently,  indeed  usually,  the  withdrawal  took  place 
at  the  very  time  when  the  need  of  money  for  the  purpose 
of  supporting  bank  loans  w^as  greatest.  It  is  evident  why 
this  should  have  been  the  case.     Government  revenues 


274  American  Banking 

are  largest  under  prosperous  conditions,  as  a  rule;  and 
prosperity  usually  co-exists  with  severe  demands  on  the 
banks  for  loans  for  the  maintenance  of  business.  The 
treasury  system  was  thus  entirely  out  of  harmony  with 
business  needs. 

The  converse  of  this  proposition,  moreover,  is  equally 
true.  If  the  government,  recognizing  the  difficulties  of 
the  case,  and  knowing  that  harm  was  practically  certain 
to  result  from  the  withdrawal  of  funds  in  large  amounts, 
sought  to  relieve  the  situation  by  redepositing  such  funds, 
then  it  could  very  seldom  overcome  the  harm  done  by 
mthdrawal.  To  select  banks  as  depositories  in  such  a 
vv'ay  as  to  redeposit  the  funds  in  practically  the  same 
manner  in  which  they  were  originally  withdrawn,  would 
be  nearly  out  of  the  question;  and  the  result  of  the  dis- 
tribution of  funds  on  any  other  principle  was  likely  to 
cause  harm.  For  example,  if  $50,000,000  of  excess 
revenue  was  taken  in  at  the  port  of  New  York  for  cus- 
toms duties,  and  was  then  deposited  in,  say,  fifty  banks 
in  the  Middle  West,  the  effect  would  be  to  withdraw  the 
money  at  those  points  where  it  was  needed  by  business, 
and  to  place  it  at  other  points  where  it  might  or  might 
not  be  needed. 

The  same  situation  exists  in  internal  revenue.  If, 
for  example,  $25,000,000  of  whiskey  taxes  was  received 
at  Peoria,  Illinois,  and  not  being  needed  for  immediate 
disbursement,  was  deposited  in  banks  on  the  Pacific 
Coast  the  same  injurious  result  would  be  produced  as 
in  the  former  instance.  It  might  be  said  that  the  dif- 
ficulty would  be  overcome  if  the  funds  were  redeposited 
at  the  same  places  at  which  they  were  withdrawn,  namely, 
in  our  illustration,  at  New  York  and  Peoria.  This  is  only 
partially  true;  but  even  assuming  that  the  assumption 
was  wholly  correct,  such  deposits  would  be  practically 


Government  Finances  and  Reserve  System      275 

out  of  tlie  question  from  a  political  standpoint.  As  a 
matter  of  fact  the  government  system  of  depositing  funds 
in  banks  has  never  been  satisfactory  under  any  adminis- 
tration, and  has  never  met  the  needs  of  the  business 
world.  The  consequent  withdrawal  and  redepositing  of 
surpluses  has  been  one  of  the  most  injurious  financial 
factors  with  which  the  country  has  had  to  contend. 

It  has  already  been  stated  that  another  consideration 
against  the  independent  treasury  system  was  that  it 
failed  to  give  the  government  the  advantage  of  up-to- 
date  and  economical  methods  of  banking  and  transfer  of 
funds.  Under  the  independent  treasury  sj^stem  such 
banking  methods  have  been  supplied  only  in  a  very  lim- 
ited and  unsatisfactory  degree.  The  sub-treasuries  have 
exercised  some  banking  functions,  transferring  money  by 
telegraph,  and  otherwise  avoiding  shipments  of  coin. 
Banks  have  been  made  use  of  under  extraordinary 
restrictions  as  checking  agents.  In  the  main,  however, 
the  effort  of  the  government  has  been  to  avoid  the  pay- 
ment and  receipt  of  funds  through  regular  banking 
channels,  and  to  do  as  much  of  its  work  as  it  could 
through  its  own  machinery  in  the  independent  treasuries. 
Although  these  treasuries  have  been  permitted  to  become 
members  of  local  clearing  houses,  so  that  they  could  col- 
lect checks  on  banks,  and  although  individual  taxpayers 
have  been  permitted  to  make  payments  in  certified  checks 
on  banks  and  otherwise,  the  practice  has  always  been 
exceedingly  slow,  uncertain,  and  unsatisfactory,  largely 
because  the  sub-treasuries  were  not  banks,  had  no  regu- 
lar banking  connections,  and  could  not,  in  the  nature  of 
the  case,  do  tlie  work  of  the  banks. 

Government  Banking  in  Foreign  Countries 

In  foreign  countries  the  case  is  quite  different.  There 
the  banking  institutions  which  act  as  agents  for  their 


276  American  Banking 

respective  governments  are  often  collectors  of  taxes, 
receiving  payment  in  ordinary  bank  checks,  carrying 
them  to  the  government's  credit,  and  in  the  same  way 
making  pajTaents  for  the  government  in  their  own  funds, 
the  balances  of  the  government  being  carried  on  the  books 
of  the  banks  like  any  others,  and,  consequently,  not  oper- 
ating to  interfere  at  all  with  the  general  use  of  the  bank's 
resources  by  the  business  world. 

The  service  thus  rendered  by  foreign  banks  has  at  all 
times  been  useful  and  economical ;  but  its  value  has  been 
more  evident  on  those  occasions  when  large  accommoda- 
tions were  needed  by  foreign  governments.  On  such 
occasions  loans  have  been  obtained  either  directly  from 
such  banks,  or,  through  their  agencies,  from  indi\TLduals 
and  corporations.  The  United  States  has  had  no  such 
resources,  but  has  been  obliged  to  rely  upon  the  sale  of 
bonds  by  popular  subscription,  a  plan  which  works  suf- 
ficiently well  when  conditions  are  undisturbed,  but  which 
is  in  grave  danger  of  breaking  down  at  any  time  of  stress 
or  difficulty  when  the  public  at  large  is  doubtful  of  the 
future  or  is  suffering  curtailment  of  its  income. 

In  times  of  difficulty,  therefore,  it  is  necessary  to  have 
the  assistance  of  some  responsible  institution  whose 
direct  duty  it  is  to  act  from  a  public  and  patriotic  stand- 
point, for  the  purpose  of  insuring  the  stability  and 
efficiency  of  the  financial  structure  of  the  country.  No 
bank  organized  as  a  purely  private  institution  is  likely  to 
fulfil  this  function  satisfactorily,  even  though  it  may  be 
managed  with  a  very  considerable  degree  of  public  spirit. 
Its  first  duty,  after  all,  is  to  its  customers  and  stock- 
holders, and  the  managers  of  the  institution  must  bear 
that  fact  constantly  in  mind  in  framing  their  policy. 
There  have  fortunately  been  but  few  occasions  since  the 
close  of  the  Civil  War  when  it  was  necessary  for  the  gov- 


Government  Finances  and  Reserve  System      277 

ernment  to  rely  largely  upon  loans,  or  to  make  appeal  to 
private  institutions.  On  those  few  occasions,  however, 
the  need  of  some  more  effective  organization  has  been 
keenly  felt,  and  this  recognition  of  the  necessities  of  the 
case  has  added  to  the  general  demand  expressed  by  scien- 
tific students  for  the  revision  or  abandonment  of  the 
independent  treasury  system,  so  as  to  introduce  a  plan 
of  financial  management  that  would  be  in  harmony  with 
modern  practice. 

The  Reserve  System  and  Fiscal  Management 

The  Federal  Reserve  Act,  in  view  of  the  foregoing 
considerations,  endeavors  to  effect  two  distinct  changes 
in  the  existing  relations  between  the  government  and  the 
reserve  institutions : 

(1)  It  provides  for  the  depositing  of  government 
funds  in  federal  reserve  banks,  which  are  authorized  to 
act  as '* fiscal  agents." 

(2)  It  authorizes  federal  reserve  banks  to  deal  in  gov- 
ernment securities. 

This,  in  short,  authorizes  the  government  to  become  a 
depositor  at  federal  reserve  banks  in  common  with  the 
various  member  banks  of  the  country,  and  through  the 
provision  that  the  reserve  banks  may  trade  in  govern- 
ment securities  (while  acting  as  fiscal  agent),  it 
practically  enables  the  government  to  resort  to  the  banks 
for  accommodation  should  it  desire  to  do  so.  In  one 
very  special  way  an  important  relationship  is  established 
between  the  government  and  the  federal  reserve  banks. 

Provision  is  made,  as  has  been  seen,  in  connection  with 
our  treatment  of  the  currency  question,  for  the  gradual 
transfer  at  a  rate  not  exceeding  $25,000,000  per  annum, 
of  the  national  bonds  now  held  by  the  national  banks,  to 
the  federal  reserve  banks.     The  reason  for  introducing 


278  American  Banking 

this  provision  is  found  in  the  fact  that  in  order  to  intro- 
duce an  improved  currency  situation,  it  was  necessary  to 
deprive  the  national  banks  of  their  exclusive  power  of 
issuing  notes  based  on  government  bonds.  This,  of 
course,  meant  that  in  all  equity,  the  banks  must,  at  some 
reasonable  time,  be  relieved  of  their  l)onds  at  a  fair 
figure.  The  federal  reserve  banks,  by  taking  over  these 
bonds,  gradually  mass  the  securities  in  their  own  hands, 
and  consequently  relieve  their  individual  members  who 
have  disposed  of  their  securities.  Ultimately  it  may  be 
assumed  that  the  bonds  will  be  refunded,  or  otherwise 
provided  for  by  the  govermnent  of  the  United  States 
upon  some  satisfactory  basis ;  but  this  must  be  regarded 
as  a  step  that  will  probably  be  a  good  while  deferred. 

Acting  upon  the  authority  conveyed  by  the  Reserve 
Act,  the  Secretary  of  the  Treasury  on  November  22, 1915, 
named  the  reserve  banks'  fiscal  agents  from  and  after 
January,  1916.  He  had  already  made  special  deposits  in 
three  of  the  banks.  It  will  be  some  time,  however,  before 
all  government  funds  are  thus  shifted,  and  no  arrange- 
ments have  been  made  for  that  purpose.  One  reason  for 
the  postponement  of  final  action  has  been  that  since  the 
organization  of  the  banks  there  has  been  little  withdrawal 
of  cash  from  circulation  as  a  result  of  payments  to  the 
government.  The  expenses  of  the  government  have  been 
more  than  equal  to  its  incomes ;  and  what  has  come  in  has 
gone  out  as  rapidly  as  it  was  paid  in  to  the  Treasury. 
Moreover,  great  ease  of  money  and  veiy  large  surplus 
reserves  have  been  established  throughout  the  country  as 
a  result  of  the  reserve  changes  incident  to  the  adoption 
of  the  Federal  Reserve  Act.  Another  reason  for  the  post- 
ponement of  complete  transfer  has  been  that  the  duty  of 
acting  as  fiscal  agent  will  entail  considerable  expense 
upon  the  reserve  banks,  and  is  a  function  that  will  require 
some  detailed  preparation.    Altogether,  therefore,  it  has 


Government  Finances  and  Reserve  System      279 

been  felt  that  no  serious  barm  would  result  from  some 
delay. 

Tbe  fact  remains  tbat  tbe  Federal  Reserve  Act  bas 
provided  wbat  bas  long  been  urged,  and  bas,  at  times, 
been  most  urgently  needed — a  means  of  keeping  tbe  funds 
of  tbe  government  itself  witb  a  mecbanism  for  placing 
and  receiving  money,  wbicb  does  not  depend  upon  tbe 
available  supply  of  government  bonds.  Equally  impor- 
tant witb  tbis  is  tbe  fact  tbat  an  efficient  financial 
mecbanism,  under  close  government  supervision,  and  in 
equally  close  toucb  witb  tbe  general  banking  system  of 
tbe  country,  bas  been  provided  for  tbe  use  of  tbe  govern- 
ment in  tbe  event  tbat  any  emergency  requiring  tbe 
placing  of  large  loans  in  bebalf  of  tbe  public  treasury, 
sbould  present  itself. 


TEST  QUESTIONS 

1.  Through  what  different  agencies  did  the  federal  govern- 
ment handle  its  treasury  funds  up  to  the  time  that  the  inde- 
pendent treasury  system  was  adopted? 

2.  What  were  some  of  the  lessons  to  be  derived  from  this 
experience  ? 

3.  What  were  the  essential  features  of  the  independent  treas- 
ury system? 

4.  Why  did  the  system  work  fairly  satisfactorily  when  govern- 
mental receipts  were  equal  to  or  less  than  expenditures,  but  fall 
down  when  receipts  greatly  exceeded  expenditures? 

5.  What  were  the  objections  to  redepositing  excessive  surplus 
funds  with  banks? 

6.  How  did  the  independent  treasury  system  deprive  the  gov- 
ernment itself  of  efficient  banking  services? 

7.  What  systems  of  government  banking  prevail  in  foreign 
countries? 

8.  What  two  changes  in  the  independent  treasury  system  does 
the  Federal  Reserve  Act  make  possible? 


CHAPTER  XIX 
the  federal  reserve  system  in  operation 

System 

The  reserve  banks  are  as  we  have  seen  co-operative 
institutions,  carried  on  for  the  benefit  of  the  community 
and  of  the  banks  themselves  by  the  banks  acting  as  stock- 
holders therein.  They  have  an  active  capital  equal  to  6 
per  cent  of  the  capital  and  surplus  of  existing  banks 
which  may  take  stock  in  the  new  enterprise. 

Regional  Character  of  Banks 

It  will  be  observed  that  in  what  has  just  been  said  the 
reserve  banks  have  been  spoken  of  as  if  they  were  a  unit. 
They  are,  however,  individually  organized  and  individu- 
ally controlled,  each  holding  the  fluid  funds  of  the  region 
in  which  it  is  organized  and  each  ordinarily  dependent 
upon  no  other  part  of  the  country  for  assistance.  The 
only  factor  of  centralization  which  has  been  provided  in 
the  new  Act  is  found  in  the  Federal  Reserve  Board, 
which  is  as  noted  a  strictly  government  organization 
created  for  the  purpose  of  inspecting  existing  banking 
institutions  and  of  regulating  relationships  between 
federal  reserve  banks  and  between  them  and  the  govern- 
ment itself.  Local  control  of  banking,  local  application  of 
resources  to  necessities,  combined  with  federal  super- 
vision, and  limited  by  federal  authority  to  compel  the 
joint  application  of  bank  resources  to  the  relief  of  dan- 

280 


Reserve  System  in  Operation  281 

gerous  or  stringent  conditions  in  any  locality  are  the 
characteristic  features  of  the  new  plan. 

The  limitations  upon  business  and  the  maintenance 
of  all  operations  upon  a  footing  of  relatively  short  time 
keep  the  assets  of  the  proposed  institutions  in  a  strictly 
fluid  and  available  condition.  They  insure  the  presence 
of  the  means  of  accommodation  when  member  banks 
apply  for  loans  to  enable  them  to  extend  to  their  clients 
larger  degrees  of  assistance  in  business.  The  govern- 
ment retains  sufficient  power  over  the  reserve  banks  to 
enable  it  to  exercise  a  directing  authority  when  necessary 
to  do  so,  but  it  in  no  way  attempts  to  carry  on  through 
its  own  mechanism  the  routine  operations  of  banking 
which  require  detailed  knowledge  of  local  and  individual 
credit  and  which  determine  the  actual  use  of  the  funds 
of  the  community  in  any  given  instance. 

It  is  this  feature  of  the  federal  reserve  system  which 
has  aroused  most  criticism  from  those  who  were  opposed 
to  it — its  so-called  regional  character — that  is  to  say, 
the  fact  that  an  effort  has  been  made  to  establish  inde- 
pendent institutions  in  different  sections  of  the  country. 
This  has  been  represented  as  an  innovation  without 
merit.  In  support  of  that  contention  it  has  been  pointed 
out  that  in  no  other  banking  systems  is  any  heed  paid  to 
geographical  divisions,  but  the  central  reserve-holding 
and  note-issuing  bank  of  each  nation  is  given*  power  to 
go  on  extending  its  operations  as  it  deems  best  and  weld- 
ing the  banking  resources  of  tlie  country  as  a  whole  into 
one. 

Somewhat  further  examination  of  the  proposition, 
however,  shows  that  the  federal  reserve  sj'^stem  with  its 
series  of  independent  banks  is  not  so  different  from  this 
''European"  plan  as  has  been  thought  by  some.  The 
area  of  the  United  States  is  about  equal  to  that  of  Europe, 


282  American  Banking 

including  Great  Britain  and  European  Russia.  So  far 
as  area  is  concerned,  then,  tliere  would  be  room  in  the 
United  States  for  a  number  of  institutions  corresponding 
to  the  total'  number  of  central  banks  throughout  the 
European  continent.  The  mere  fact  that  international 
lines  divide  the  Bank  of  France  from  the  Bank  of  Eng- 
land or  the  Bank  of  Germany,  has  no  relation  to  the 
economics  of  the  situation.  It  is  a  fact  that  no  such 
extent  of  territory  as  the  United  States  is  dealt  with  by 
one  single  central  bank. 

The  federal  reserve  system  with  its  series  of  reserve 
holding  institutions,  therefore,  does  in  fact  correspond 
much  more  nearly  to  European  practice  than  a  single 
central  institution  with  branches  would  have  done.  Each 
federal  reserve  bank  includes  within  its  district  a  terri- 
tory which,  as  the  nation  expands  and  its  business 
increases,  will  rank  with  the  territory  tributary  to  one 
of  the  European  central  institutions.  By  establishing  a 
Federal  Reserve  Board,  vested  with  power  to  harmonize 
and  unify  the  operations  of  the  federal  reserve  banks, 
the  federal  reserve  system  goes  a  step  further  than  the 
European  central  banking  systems,  inasmuch  as  it  pro- 
vides for  a  joint  and  co-operative  control  of  the  credit 
situation. 

The  inclusion  of  a  large  proportion  of  commercial 
banks  is,  however,  necessary,  because  of  the  necessity  of 
making  the  institutions  sufficiently  strong  to  be  effective. 
Consequently,  national  banks  are  required  to  enter  the 
system  under  penalty  of  being  obliged  to  go  into  liquida- 
tion and  surrender  their  charters.  It  was  seen,  however, 
from  the  time  the  Federal  Reserve  Act  was  first  pro- 
posed, that  the  limitation  of  the  system  to  national  banks 
might  not  be  a  good  thing.  If  state  banks  continue  to  be 
as  numerous  and  as  powerful  as  at  present,  and  to  include 


Reserve  System  in  Operation  283 

within  their  scope  a  good  deal  more  than  one-half  of  the 
banking  capital  of  the  country,  it  was  desirable  to  get 
them  into  the  new  system.  This  could  be  done  only  by 
providing  for  another  class  of  members  of  the  system  and 
holding  out  to  state  banks  the  necessary  inducement  to 
bring  them  in.  It  is  evident  that  the  larger  the  per- 
centage of  all  the  banks  which  become  members  of  the 
system,  the  more  nearly  will  it  be  true  that  facilities  have 
been  afforded  to  all  classes  of  business  men  and  borrow- 
ers for  obtaining  the  advantage  which  comes  from 
organization  and  combination. 

Branch  Banking 

A  further  development  of  the  system  which  will  nec- 
essarily come  as  the  new  banks  are  more  and  more  firmly 
established  and  as  their  business  becomes  larger  and 
larger,  is  the  establishment  of  branch  banks.  As  will 
be  seen  from  the  map  already  presented,  some  of  the 
federal  reserve  districts  are  very  large.  Some  include 
several  points  which  are  sufficiently  important  business 
centers  to  warrant  the  creation  of  independent  banking 
units.  Still  others  are  so  laid  out,  geographically  speak- 
ing, that  it  is  hard  to  manage  the  affairs  of  the  whole 
district  from  one  single  point.  In  all  such  cases  the 
natural  development  to  be  expected  will  be  the  estab- 
lishment of  branch  reserve  banks. 

These  branches  will  be,  in  practically  all  particulars, 
identical  in  function  with  the  parent  banks.  Their  local 
boards  of  directors  will,  however,  be  able  to  determine 
with  greater  accuracy  than  the  directors  of  the  parent 
institutions  the  amount  of  credit  to  which  would-be  bor- 
rowers are  entitled,  while  they  will  be  able  to  handle 
more  quickly  than  the  parent  institutions  the  checks  and 


284  American  Banking 

other  items  originating  within  the  respective  districts, 
and  requiring  to  be  cleared  on  the  books  of  the  banks. 

From  the  standpoint  of  structure  or  organization, 
therefore,  it  may  be  expected  that  in  the  near  future  a 
series  of  branch  institutions  will  develop.  Only  a  few 
such  branches  have  as  yet  been  provided  for,  and  it  is  still 
uncertain  whether  in  creating  a  branch  within  a  given 
district,  an  independent  territory  will  always  be  assigned 
to  such  a  branch,  or  whether  it  would  be  permitted  to  do 
business  with  any  member  bank  throughout  the  district 
which  may  choose  to  resort  to  it  rather  than  go  to  the 
head  office  of  the  parent  institution.  The  branch  early 
created  at  New  Orleans  was,  however,  given  a  separate 
territory  of  its  own. 

There  are  some  questions  connected  with  this  situa- 
tion that  may  turn  out  decidedly  interesting.  If  a  number 
of  branches  should  be  established  in  any  given  district, 
the  natural  result  would  seem  to  be  either  that  the  federal 
reserve  bank  of  the  district  would  become  a  central  office, 
taking  charge  of  their  affairs  in  general,  and  overseeing 
them  (but  probably  not  doing  much  business  itself,  the 
actual  work  being  done  at  the  branches),  or  else  that  it 
would  practically  assume  a  status  co-ordinate  with  that 
of  its  own  branches.  Indeed,  if  in  some  districts  it 
should  happen  that  branches  were  more  successful  in 
directing  business  to  themselves,  while  the  parent  insti- 
tution had  perhaps  been  erroneously  located  in  the  first 
instance,  the  latter  might  be  placed  in  an  embarrassing 
situation,  because  of  the  fact  that  its  subordinate 
branches  were  getting  more  actual  business  than  the 
home  office.  All  this  is  a  question  which  must  be  deter- 
mined largely  on  the  basis  of  experience.  There  are  no 
definite  canons  of  theory  and  certainly  no  provision  in 
the  Act  itself  that  would  control  the  disposition  of  such 
issues. 


r^ 


Reserve  System  in  Operation  285 

Beoad  Principles  of  the  Plan 

It  is  now  necessary  to  devote  some  attention  to  the 
new  legislation  from  the  broad  general  standpoint  and 
to  note  the  significance  of  the  measure  as  it  finally  became 
law.  To  the  student  of  banking  it  need  hardly  be  said 
that  the  striking  aspects  of  the  legislation  are  these 
three : 

(1)  The  creation  of  a  general  discount  market  for 
commercial  paper. 

(2)  The  systematic  pooling  of  reserves  of  existing 
banks. 

(3)  The  provision  of  an  elastic  currency. 

In  the  multitude  of  details  provided  by  the  legislation, 
and  in  the  various  adjustments  rendered  necessary  by 
it  with  respect  to  government  deposits,  bank  reserves, 
examinations,  and  other  more  or  less  important  matter, 
it  is  noticeable  throughout  that  everything  done  has  been 
for  the  purpose  of  promoting  the  objects  already  enum- 
erated, and  of  insuring  the  transformation  of  American 
banking  from  its  present  basis  of  organization  to  a  pro- 
posed new  one.  If  these  chief  objects  shall  be 
accomplished  in  actual  practice,  the  legislation  will  have 
been  amply  warranted,  and,  it  need  hardly  be  said  to  a 
professional  reader,  "will  completely  revolutionize  the 
banking  and  credit  situation,  to  the  great  profit  not  only 
of  the  banks  themselves  but  of  their  customers.  That  the 
banks  will  greatly  profit  under  the  bill  is  susceptible  of 
easy  mathematical  demonstration.  That  the  business 
public  will  profit  in  a  far  higher  degree  than  the  banks  is 
less  obvious,  but  is  a  fact  which  constitutes  the  chief 
basis  for  the  legislation.  Were  it  not  true,  the  time  and 
effort  expended  in  securing  the  present  result  would 
scarcely  have  been  warranted.    In  its  real  essence,  the 


1 


286  American  Banking 

new  law  is  in  fact  and  in  the  best  sense  of  the  term  a 
*' business  man's  measure." 

Heretofore,  American  banking  has  been  too  largely  an 
agency  in  the  service  of  speculation.  This  statement  is 
borne  out  by  the  following  considerations : 

(1)  The  rates  controlling  the  flow  of  gold  out  of  the 
United  States  have  been  those  dictated  by  the  call-loan 
market,  not  those  prevailing  in  the  commercial  discount 
market. 

(2)  The  funds  which  the  banks  desired  to  have  ready 
to  hand  have  been  customarily  invested  in  demand  loans 
on  stocks  rather  than  in  quick  commercial  paper  or  short- 
term  foreign  exchange. 

(3)  In  times  of  crisis  or  pressure,  the  banks  have  short- 
ened loans  in  this  country  instead  of,  as  in  foreign 
countries,  enlarging  them  to  accommodate  legitimate 
borrowers.  If  they  have  undergone  sacrifice,  it  has  been 
for  the  primary  purpose  of  upholding  and  safeguarding 
the  stock  market. 

The  new  Act  changes  this  condition  in  the  following 
ways : 

(1)  It  transfers  a  small  but  necessary  fraction  of  the 
ultimate  reserve  money  of  the  country  to  government- 
inspected  institutions,  located  in  various  parts  of  the 
country,  where  they  will  be  quickly  responsive  to,  and  in 
sympathy  with,  business  necessities,  and  prescribes  by 
rigid  rules  that  these  funds  shall  be  applied  solely  to  com- 
mercial needs  and  to  nothing  else,  since  the  loans  that 
may  be  made  by  these  new  banks  are  narrowly  restricted 
in  term  and  in  character. 

(2)  It  broadens  the  methods  of  doing  business  allowed 
to  national  banks,  so  far  as  relates  to  investments  in 
legitimate  conunercial  paper,  and  narrows  them  corre- 


Reserve  System  in  Operation  287 

spondingly,  so  far  as  relates  to  investments  in  stocks  and 
bonds. 

(3)  It  increases  the  loaning  power  of  the  banks  of  a 
given  community,  and  promises  to  such  banks,  when  in 
need  of  assistance,  the  support  which  will  be  derived 
from  the  combined  resources  of  their  fellow  banks  in  the 
same  community  or  region. 

Its  effort  is  thus  to  promote  the  growth  of  commercial 
credit  and  to  protect  that  credit  when  brought  into  exist- 
ence. It  differs  from  the  present  law,  in  that  it  refuses 
longer  to  look  upon  the  business  man  as  one  who  ''bor- 
rows money"  at  a  bank,  and  regards  him  as  one  who 
manufactures  a  commodity — commercial  credit  and  the 
paper  representing  it — which  he  sells  to  banks,  and  w^iich 
it  is  the  function  of  the  latter  to  insure  and  to  keep  liquid. 
It  regards  the  duty  of  the  bank  as  being,  above  all  things 
else,  that  of  maintaining  specie  payments  and  sustain- 
ing the  solvency  of  the  community;  and  it  declines  to 
consider  the  banker  as  one  whose  duty  it  is  to  promote 
enterprises,  float  issues  of  securities,  or  aid  in  stock 
speculation.  That  all  these  phases  of  financial  effort  have 
their  place — a  desirable  place  when  properly  defined  and 
recognized — the  Act  fully  concedes,  but  it  holds  in  prin- 
ciple that  that  place  is  not  found  in  connection  with  the 
work  of  commercial  banks. 

An  Act  in  Aid  of  Business 

If  the  business  community  contents  itself  Avith  simply 
continuing  its  present  methods  of  operation,  it  will 
derive  great  advantage  from  the  law.  It  will  find:  (1) 
that  local  banks  will  be  able,  by  rediscounting  the  paper 
of  local  enterprises,  to  provide  the  funds  needed  by  such 
enterprises  in  their  operations;  (2)  that  there  will  be 
no  such  wide  fluctuations  of  interest  rates  either  s'eo- 


288  American  Banking 

graphically  or  from  season  to  season  as  now  exist;  (3) 
that  there  will  be  no  necessity  of  emergency  measures  to 
safeguard  the  country  from  the  possible  results  of  finan- 
cial panic  or  stringency.  Credit  will  be  more  simply 
available,  cheaper,  and  more  equitably  open  to  all. 

Not  the  least  advantage  to  the  business  man  will  be 
found  in  the  provisions  with  respect  to  bank  examina- 
tions; since  through  these,  it  may  be  hoped,  many 
operations  which  have  been  the  disgrace  of  American 
banking  in  the  past  will  be  early  detected  and  corrected 
before  they  have  had  time  to  eat  out  the  heart  of  insti- 
tutions which  might  otherwise  have  continued  sound  and 
solvent.  This  is  equivalent  to  saying  that,  under  the  new 
law,  credit,  even  if  there  be  no  change  in  business  meth- 
ods, will  be  cheaper  and  more  evenly  diffused,  as  well  as 
more  steady  and  more  certainly  to  be  counted  upon  by 
those  who  do  business  by  acceptable  methods. 

But  the  community  will  not  gain  the  greatest  advantage 
from  the  measure  if  it  adheres  merely  to  established 
types  of  operation.  The  new  Act  provides  for  the  crea- 
tion of  a  true  discount  market,  such  as  has  existed  for 
many  years  in  every  European  country.  This  means  that 
every  merchant  of  established  local  credit  may  in  the 
future  count  upon  a  free  sale  for  his  paper  throughout 
the  reserve  district  in  which  he  is  situated,  and  to  a  some- 
what lesser  degree  generally  throughout  the  country. 
The  rediscount  principle,  when  fully  worked  out,  taken 
in  connection  with  the  use  of  the  acceptance  system,  will 
enable  the  sound,  even  though  small,  manufacturer  or 
trader  to  get  the  advantage  of  the  best  rates  of  commer- 
cial credit  that  prevail  anywhere  within  his  region  of  the 
country.  If  there  is  capital  to  spare — unemployed  and 
seeking  occupation — he  may  expect  that,  through  the 
general  sale  of  bills  under  the  new  system,  such  capital 


Reserve  System  in  Operation  289 

will  be  available  for  the  purchase  of  his  paper  and  will 
be  so  employed.  By  the  judicious  use  of  the  acceptance, 
the  local  bank  will  be  enabled  to  facilitate  the  movement 
of  goods  into  and  out  of  the  country,  and  will  at  once 
make  the  utmost  of  its  own  capital  and  at  the  same  time 
enable  its  clients  to  gain  the  widest  employment  for  their 
own  resources.  The  net  result  of  these  various  influences 
should  be : 

(1)  Considerable  reduction  in  average  rates  of  interest 
on  commercial  paper  throughout  the  United  States. 

(2)  Very  great  reductions  in  the  rates  in  certain  sec- 
tions remote  from  commercial  centers. 

(3)  Stability  and  certainty  in  distribution  of  credit. 

(4)  Creation  of  new  and  more  convenient  types  of 
paper. 

Reduced  CoLLECTioisr  Chakges 

Not  the  least  important  of  the  provisions  of  the  new 
measure  is  that  which  assures  to  the  business  man  the 
cheaper  collection  and  transmission  of  his  funds.  The 
Act  provides  for  the  deposit  of  many  classes  of  checks 
and  drafts  at  par  with  federal  reserve  banks,  and  it 
thereby  aims  to  establish  a  parity  of  exchange  among 
banks  within  every  federal  reserve  district  and  then 
between  the  federal  reserve  banks  themselves.  It  per- 
mits charges  to  be  made  by  member  banks  that 
correspond  to  the  actual  cost  to  them  of  collecting  funds 
for  their  clients,  but  it  places  these  charges  under  fed- 
eral control  and  specifically  authorizes  the  Federal 
Reserve  Board  to  restrict  them  by  rule. 

This  is  as  it  should  be.  In  years  past  American  com- 
merce has  suffered  severely  from  the  infliction  of  high, 
not  to  say  excessive,  charges  for  check  collection  upon 
business  men  throughout  the  country.     So  far  has  this 


290  American  Banking 

tjY>e  of  exaction  been  carried  that  it  was  testified  bj^ 
country  banks  tliat  in  many  instances  fully  one-half  of 
their  earnings  were  due  to  such  charges,  and  that  they 
could  not  get  along  without  them.  Such  exorbitant  rates 
were  maintained  by  agreements  among  banks  and  the 
development  of  a  code  of  what  is  called  "banking  ethics," 
whereby  banks  were  prevented  from  cutting  the  excessive 
charges  had  they  been  so  minded. 

Much  of  this  evil  may  be  expected  now  to  disappear. 
The  banks  will  be  restricted,  when  the  system  is  fully  in 
operation,  to  moderate  rates ;  and  thereby  a  great  burden 
Avill  be  lifted  from  the  backs  of  the  commercial  com- 
munity. In  the  opinion  of  some,  this  burden  will  in  part 
be  removed  by  the  process  of  clearing  checks  instead  of 
collecting  them,  which  is  to  be  inaugurated  under  the 
new  system.  But  whether  it  does  so  disappear  or  not,  the 
merchants  of  the  country  will  be  relieved  of  the  excess 
charges  made  by  the  banks  in  the  way  already  indicated. 
In  many  instances  this  will  save  thousands  of  dollars 
annually  to  individual  firms. 

Effects  Economy  in  Gold 

A  less  direct,  although  most  important,  aspect  of  the 
new  law  in  its  relation  to  business  is  seen  in  the  economy 
of  gold  that  will  be  effected  under  it.  The  original  bill 
provided  for  maintaining  reserves  at  about  their  present 
height,  in  the  belief  that  ultimately  the  governing  board 
would  let  them  all  down  to  the  level  prescribed  for  coun- 
try banks.  The  final  act  makes  a  very  great  reduction  in 
reserve  requirements  and  "\\ill  release  a  great  volume  of 
money  after  all  new  needs  for  the  reserves  of  the  federal 
reserve  t^nks  have  been  complied  with.  That  this  will 
produce  some  danger  of  inflation  during  the  transition 
period — a  danger  that  will  need  to  be  carefully  guarded 


Reserve  System  in  Operation  291 

against  by  the  best  sense  of  the  banking  community — is 
evident.  After  that  period  has  been  passed,  the  reduction 
in  the  amount  of  gold  that  must  be  carried  constantly  in 
bank  vaults  will  really  be  far-reaching. 

The  United  States  has  for  many  years  been  obliged  by 
its  antiquated  banking  methods  to  use  much  larger  gold 
reserves  than  any  other  country  in  the  world  in  propor- 
tion to  business  done.  This  was  as  much  a  waste  as  any 
other  unnecessary  employment  of  capital.  It  meant  that 
the  actual  cost  of  operating  a  bank,  which  had  to  be 
recovered  from  borrowers  in  interest  charges,  was  neces- 
sarily greater  in  proportion  to  the  enlarged  expense  of 
carrying  an  unnecessarily  high  reserve.  This  cost  in 
turn  was  heightened  in  times  of  panic  by  the  very  great 
expense  that  had  to  be  incurred  for  the  sake  of  getting 
more  gold  with  which  to  build  up  the  reserves  when  the 
latter  had  been  depleted.  By  lessening  this  important 
item  of  cost  in  banking  and  by  reducing  the  exceptional 
and  sporadic  elements  of  cost  growing  out  of  panic  con- 
ditions from  time  to  time,  reductions  of  interest  rates  will 
be  rendered  feasible  and  will  ultimately  tranfer  their 
effect  to  the  commercial  world. 

In  this  same  connection  it  deserves  to  be  noted  that  the 
new  system  will  also  render  the  control  of  the  country's 
gold  supply  much  easier  and  simpler.  It  provides  the 
machinery  for  dictating,  upon  occasion,  changes  in  redis- 
count rates  intended  to  prevent  exportation,  and  other 
changes  intended  to  aid  importation.  The  mechanism 
will  be  automatic  and  effective  and  will  replace  the 
antiquated,  costly,  and  not  very  effective  methods  that 
have  had  to  be  followed  in  the  past.  This  will  directly  aid 
the  man  engaged  in  foreign  trade  and  will  immensely 
assist  in  the  management  of  foreign  exchange  operations. 
Exchange  will  be  furnished  at  much  less  cost  to  the  com- 


292  American  Banking 

munity,  and  our  rates  of  exchange  will  be  much  more 
closely  harmonious  with  those  of  the  rest  of  the  world. 

Aid  in  Foeeign  Trade 

In  times  past,  there  has  been  constant  and  well-founded 
complaint  that  American  business  men  engaged  in  for- 
eign trade  or  operating  branches  of  their  houses  abroad 
were  obliged  to  depend  upon  foreign  banks  for  their 
accommodation  or  else  finance  themselves  practically 
unaided.  Where,  as  in  the  South  American  trade,  it  has 
been  necessary  for  the  American  business  man  to  resort 
to  branches  of  European  banks  established  in  the  various 
countries,  it  has  been  asserted  that  such  banks,  working 
as  they  did  in  close  harmony  with  merchants  of  their 
own  nationality,  were  often  unfaithful  to  their  American 
clientele,  allowing  competitors  to  know  their  business 
operations,  and,  when  disposed  to  do  so,  cutting  off  their 
credit  in  favor  of  such  rivals.  These  charges  have  had 
more  or  less  foundation,  and  it  has  certainly  been  true 
that  the  banking  accommodation  of  Americans  engaged 
in  foreign  ojDcrations  has  been  poor  even  at  the  best. 

The  new  Act  provides  for  meeting  these  conditions 
through  the  extension  of  the  banking  system  in  foreign 
countries  in  two  ways — it  permits  member  banks  to  apply 
for  and  receive  under  certain  conditions  of  capitalization, 
etc.,  permission  to  establish  branches  of  their  own 
abroad;  and  it  provides  for  the  establishment  abroad  of 
agencies  and  offices  of  federal  reserve  banks. 

The  powers  granted  by  the  Federal  Reserve  Act  with 
reference  to  foreign  operations  of  federal  reserve  banks 
are  very  large,  and  it  would  appear  that  the  foreign 
agencies  of  offices  of  the  reserve  banks  might  engage  in 
practically  any  class  of  business  they  chose  (always  pro- 
vided it  was  of  a  commercial  and  short-term  character), 


Reserve  System  in  Operation  293 

dealing  wdth  individuals,  firms,  or  corporations,  at  will. 
This  situation  opens  up  a  large  possibility  in  the  develop- 
ment of  foreign  banking  upon  a  scale  commensurate  with 
and  similar  to  that  which  is  characteristic  of  foreign 
banking  institutions. 

Up  to  date  practically  nothing  in  this  direction  has  been 
done,  for  the  reason,  among  others,  that  financial  condi- 
tions in  European  countries  are  too  disturbed  to  permit 
of  any  serious  exploitation  of  the  field  there  with  a  proper 
measure  of  safety.  In  time,  however,  the  reserve  banks 
will  naturally  establish  offices  abroad  if  only  for  the 
purpose  of  dealing  with  the  question  of  foreign  remit- 
tances. Wlien  that  time  comes  the  question  will 
necessarily  be  raised  whether  such  offices  shall  be  general 
offices,  acting  for  the  system  as  a  whole,  or  whether  they 
shall  represent  federal  reserve  banks  individually.  The 
former  alternative  is  the  one  which  would  seem  to  be 
indicated  by  the  logic  of  the  case.  It  may  be  expected 
that  on  some  basis  of  co-operation  the  federal  reserve 
banks  will,  therefore,  create  joint  offices  particularly  in 
those  financial  centers  where  it  is  desired  to  operate,  and 
that  these  joint  offices  will  handle  for  the  several  reserve 
banks  such  operations  as  various  institutions  may  see  fit 
to  commit  to  their  charge. 

Member  banks  themselves  may  establish  branches 
abroad  and  under  the  supervision  of  the  Eeserve  Board 
operate  them  on  very  broad  and  liberal  terms  of  business 
management.  Disturbed  foreign  conditions  and  depres- 
sion of  business  at  home  have  likewise  restricted  the 
growth  of  such  foreign  branches  of  American  banks,  only 
a  few  having  thus  far  been  authorized  by  the  Federal 
Eeserve  Board.  As  foreign  trade  advances,  however,  it 
is  reasonable  to  expect  that  many  large  American  insti- 
tutions will  establish  branches  in  other  countries,  and 


294  American  Banking 

this  will  not  be  a  movement  in  competition  with  the 
branches  of  the  federal  reserve  banks.  There  will  natu- 
rally be  the  same  distinction  between  the  kind  of  business 
done  by  branches  of  resen^e  banks  and  branches  of  mem- 
ber banks  abroad  that  there  is  between  the  operations 
of  reserve  banks  and  member  banks  at  home.  Member 
banks  will  engage  in  many  types  of  operation  which  are 
not  appropriate  for  reserve  banks,  while  reserve  banks 
will  limit  themselves  rigidly  and  closely  to  short  commer- 
cial paper  and  will  not  be  able  to  engage  in  financing  or  in 
promoting  enterprises  of  any  kind. 

As  the  system  becomes  established  abroad  it  should 
end  the  constant  complaint  about  lack  of  banking  accom- 
modations and  should  place  Americans  in  the  foreign 
trade  upon  a  footing  of  equality  with  foreign  compet- 
itors. It  is  true  that,  as  has  recently  been  noted,  the 
United  States  lacks  a  supply  of  well-trained  bank  man- 
agers acquainted  with  foreign  practice  and  ready  to 
expatriate  themselves  for  the  time  necessary  to  carry  on 
a  branch  office  elsewhere.  Such  shortage  of  trained  men 
will,  however,  be  overcome  as  soon  as  opportunity  of  a 
real  sort  is  offered,  just  as  the  lack  of  well-prepared 
consuls  has  already  been  overcome  in  a  very  large  degree 
since  the  consular  service  was  placed,  at  least  partially, 
upon  a  footing  of  efficiency,  and  promotions  made  in  a 
measure  according  to  merit.  It  may  be  confidently 
expected  that  American  foreign  trade  will  within  a  short 
time  be  afforded  all  the  assistance  that  it  can  reasonably 
call  for  under  the  very  liberal  provisions  now  made  for 
foreign  branch  banking. 

*    Relatiox  to  Industry 

The  general  management  of  the  new  system  has  wisely 
been  taken,  in  part,  out  of  the  hands  of  bankers ;  and  has 


Reserve  System  in  Operation  295 

been  placed,  in  a  measure,  in  those  of  men  representing 
commerce,  industry,  and  agriculture.  This  is  not  because 
of  distrust  of  bankers  or  because  of  a  feeling  that  special 
discrimination  should  be  shown  in  favor  of  given  classes 
in  the  community.  It  is  due  to  a  feeling,  everywhere 
recognized,  that  the  industrial  portion  of  the  community 
should  be  given  a  voice  in  the  management  of  the  com- 
mercial credit  of  the  nation,  and  that  banking  is,  in  its 
highest  and  best  sense,  a  semi-public  function,  carried  on, 
not  merely  as  a  means  of  profit,  but  for  the  sake  of  pro- 
viding for  social  wants  in  the  creation  of  credit  and  the 
maintenance  of  redemption.  The  business  man,  in  the 
best  sense  of  the  word,  is  expected  to  take  a  living  and 
direct  part  in  the  work  of  carrying  on  the  new  system,  no 
matter  whether  he  owns  stock  in  any  bank  or  not — and 
perhaps  the  more  freely  if  he  does  not  own  such  stock. 
He  will  thus  be  drafted  into  service  because  of  the  sig- 
nificance of  banking  to  every  class  and  section  of  the 
country,  and  because  of  the  perception  that  it,  like  trans- 
portation, is  no  longer  to  be  considered  solely  a  private 
money-making  industry. 

To  get  the  full  advantage  of  the  system,  the  business 
man  needs  to  arouse  himself  to  a  new  conception  of  his 
functions  and  duties.  He  needs  to  bring  his  methods  of 
borrowing  and  his  view  of  commercial  paper  into  har- 
mony with  European  practice,  to  accustom  himself  to 
prompt  payment  of  notes  and  bills  without  extended 
renewals  and  to  the  putting  of  his  business  upon  a  short- 
term  cash  basis.  He  needs  further  to  familiarize  him- 
self with  the  idea  of  banking  in  the  larger  sense,  and  to 
prepare  to  share  actively  in  the  management  of  the  new 
reserve  banks  and  their  branches,  in  which  important 
places  have  been  reserved  for  him. 


296  American  Banking 

Unifying  the  Banking  System 

An  important  feature  of  the  Federal  Reserve  Act  is 
seen  in  the  provision  it  makes  for  the  unification  of  the 
banking  system  of  the  United  States.  The  earlier  drafts 
of  the  Glass  bill  which  afterwards  became  the  Federal 
Reserve  Act,  differed  in  theory  as  respects  this  matter, 
from  the  final  law.  The  first  draft  proceeded  upon  the 
view  that  with  entrance  to  the  national  banking  system 
perfectly  free,  and  with  the  system  entirely  under  fed- 
eral control,  it  was  desirable  to'  limit  membership  in 
federal  reseiwe  banks  to  national  institutions.  Conse- 
quently it  was  provided  that  only  national  banks  should 
be  permitted  to  become  members  of  federal  reserve 
banks.  This,  however,  was  finally  altered  so  as  to  admit 
state  banks  and  trust  companies  to  the  new  system,  while 
national  banks  might  receive  savings  deposits  and  exer- 
cise certain  trust-company  powers. 

The  theory  of  the  Act  as  thus  altered  is  plain.  It  was 
based  upon  the  idea  that  unification  of  the  whole  banking 
system  of  the  nation  was  desirable ;  but  siich  unification 
was  to  be  obtained  by  rendering  the  functions  of  national 
banks  similar  in  a  certain  degree  to  those  of  state  banks 
and  trust  companies.  Federal  reserve  banks  were,  on 
this  theory,  rendered  more  than  ever  necessary,  because 
the  savings  bank,  real  estate,  and  trust-company  pro- 
visions of  the  Federal  Reserve  Act  would  inevitably 
tend  to  reduce  in  some  degree  the  liquid  character  of  tlie 
national  banks,  thus  rendering  a  substitute  desirable  or 
necessary,  and  this  substitute  would,  in  the  natural  course 
of  events,  be  supplied  by  the  federal  reserve  system. 

Almost  immediately  after  the  adoption  of  the  Federal 
Reserve  Act  there  was  a  demand  from  national  banks  for 
the  establishment  of  regulations  under  which  they  could 


Reserve  System  in  Operation  297 

gain  the  advantage  of  the  5  per  cent  reserve  requirement, 
and  these  regulations  were  speedily  issued. 

In  the  same  way  an  urgent  demand  for  the  granting  of 
trust-company  powers  was  heard,  but  the  Federal 
Eeserve  Board  did  not  deem  it  wise  to  take  action  on  this 
subject  for  some  months  after  its  organization.  Later  it 
took  the  position  that  all  it  can  grant,  under  the  terms 
of  the  law,  is  power  to  exercise  the  trust-company  func- 
tions when  not  in  contravention  of  state  or  local  law,  and 
that  the  determination  of  the  legality  of  the  functions 
must,  therefore,  be  left  to  the  individual  banks  them- 
selves, in  order  that  they  may  satisfy  their  own  minds 
of  the  legality  of  what  they  propose  to  do  before  proceed- 
ing to  engage  in  that  class  of  business,  or  else  take  the 
consequences  in  the  form  of  subsequent  legal  difficulties. 

The  question  of  admitting  state  banks  to  the  federal 
reserve  system  was,  as  already  indicated,  very  closely 
allied  to  the  question  of  granting  the  trust-company  pow- 
ers previously  referred  to ;  but  the  Board  did  not  act  upon 
it  until  June  7,  1915,  when  it  issued  a  circular  permit- 
ting state  banks  to  enter  the  federal  reserve  system. 

The  Act  provides  that  every  state  bank  shall  comply 
with  the  requirements  that  are  imposed  upon  national 
banks  with  regard  to  capitalization  in  relation  to  popula- 
tion, and  in  regard  to  the  amount  of  reserves  maintained. 
Such  state  banks  must,  however,  conduct  themselves  in  a 
general  way  on  the  basis  of  banking  management  that  is 
laid  down  for  national  institutions  under  the  Federal 
Eeserve  Act  and  in  the  new  regulation s^.although  it  may 
be  said  in  passing  that  there  is  nothing  in  either  to  inter- 
fere with  the  regular  banking  operations  of  those  banks 
which  are  organized  under  state  law,  or  to  prevent  them 
from  taking  advantage  of  those  broader  provisions  of 
legislation  which  are  found  on  the  statute  books  of  some 


298  American  Banking 

states.  But,  in  a  general  way,  state  banks  which  enter 
the  federal  reserve  system  must  live  up  to  certain  require- 
ments as  to  capital  and  reserves,  and  must  submit  to 
examination  on  the  part  of  the  Board  or  the  federal 
reserve  bank  of  the  district. 

It  seems  to  have  been  supposed  by  some  banks  that 
they  must  enter  the  federal  reserve  system  in  order  to 
get  the  benefit  of  it.  That  is  only  partially  true.  If  the 
federal  reserve  system  attains  the  objects  for  which  it  is 
intended,  it  will  do  so  because  of  the  fact  that  it  modifies 
the  w^hole  banking  situation.  It  will  provide  a  market  for 
commercial  paper  and  will  tend  to  bring  discount  rates  to 
a  degree  of  uniformity  that  has  never  before  been  pos- 
sible. When  the  conditions  are  such  throughout  the 
country  that  commercial  paper  of  known  value  can  be 
marketed,  and  when,  through  the  development  of  the 
principle  of  combined  reserves,  panic  dangers  are  largely 
eliminated,  every  institution,  whether  a  member  of  the 
reserve  system  or  not,  will  get  the  benefit  of  the  improved 
situation.  Of  course,  this  result  cannot  be  reached  unless 
a  sufficient  number  of  commercial  banks  are  joined 
together  in  the  system.  Enough  are  already  members 
practically  to  insure  this  state  of  things,  but  the  assur- 
ance \vill  become  more  and  more  distinct  as  more  and 
more  of  the  commercial  banks  join. 

Should  they  all  enter,  the  system  will  gain  no  addi- 
tional strength  by  the  incorporation  of  members  whose 
business  is  of  a  primarily  investment  character,  even 
though  they  technically  comply  with  the  reserve  require- 
ments. Neither  mil  the  institutions  themselves  profit 
particularly  by  such  membership.  They  will  get  the 
advantages  of  the  system  in  any  case  by  being  enabled 
to  borrow  under  more  favorable  conditions  from  the 
member  banks  which  have  rendered  their  own  assets  more 


Reserve  System  in  Operation  299 

liquid  through  their  own  membership  in  the  system,  and 
have  thereby  enabled  themselves  readily  and  regularly 
to  afford  such  aid  as  may  be  asked  for  by  their  banking 
customers. 

The  amendment  of  June  21,  1917,  relating  to  state 
banks  is  practically  an  enactment  into  law  of  the  Board's 
regulations  on  that  subject  already  in  effect.  By  giving 
the  provisions  the  sanction  and  permanency  of  statutory 
enactment,  it  is  hoped  that  state  banks  will  enter  the 
system  in  larger  numbers  and  with  greater  confidence. 

TEST  QUESTIONS 

1.  What  is  the  nature  of  the  federal  reserve  banks? 

2.  Explain  their  regional  character. 

3.  Compare  the  regional  banks  with  the  central  banks  of 
European  countries. 

4.  What  is  the  nature  and  function  of  branch  banks  under  the 
federal  reserve  system? 

5.  Explaia  "Heretofore  American  banking  has  been  too 
largely  an  agency  in  the  service  of  speculation." 

6.  How  does  the  new  act  remedy  these  conditions? 

7.  Explain  the  new  act  as  an  aid  to  business.  Show  by 
various  practical  applications. 

8.  How  does  the  federal  reserve  system  reduce  collection 
charges  ? 

9.  How  does  the  new  system  effect  economy  m  gold? 

10.  Explain  the  advantages  which  the  system  offers  in  foreign 
trade. 

11.  On  what  conditions  may  state  banks  become  member  banks 
of  the  federal  reserve  system? 

12.  Is  such  a  move  desirable  from  the  standpoint  of  the  finan- 
cial strength  of  this  country?  Of  the  state  banks  themselves? 
Why? 


CHAPTER  XX 

BANKING  IN  THE  UNITED   STATES  AND  ABROAD 

The  banking  experience  of  the  United  States  has  been 
developed  along  lines  entirely  different  from  those  fol- 
lowed by  European  systems  although,  as  has  been  seen, 
the  United  States  embarked  on  its  first  banking  experi- 
ment by  chartering  the  First  Bank  of  the  United  States 
on  a  basis  substantially  similar  to  that  upon  which  the 
great  banks  of  foreign  countries  were  founded.  The  sys- 
tems of  the  several  states,  which  superseded  the  First 
Bank  of  the  United  States,  then  continued  contempo- 
raneously with  the  Second  Bank,  and  at  last  culminated 
in  the  national  banking  system.  These  systems  were 
local  products,  the  outgrowth  of  special  conditions  in  this 
country,  and  were  not  closely  modeled  after  any  foreigTi 
banking  systems.  Only  such  features  were  adopted  as 
seemed  to  be  well  adapted  to  our  needs.  The  effort  to 
improve  the  note-issue  features  of  the  national  banking 
system,  particularly,  has  given  rise  to  long  continued 
inquiries  into  foreign  banking  and  to  the  offering  of 
various  plans  considered  well  adapted  to  produce  in  the 
United  States  the  beneficial  results  that  have  been 
obtained  under  somewhat  different  conditions  elsewhere. 

Much  can  be  learned  from  the  study  of  foreign  banks, 
but  it  is  well  to  bear  in  mind  that  these  banks  are  organ- 
ized in  countries  with  a  different  t}^e  of  government 
and  with  business  methods  that  are  on  the  whole  decid- 
edly unlike  our  o^\ti.     A  banking  system  must  not  be 

300 


Banking  in  the  United  States  and  Abroad        301 

considered  as  a  thing  apart  but  looked  at  in  the  light  of 
actual  experience  and  as  an  element  in  the  commercial 
structure  to  which  it  belongs. 

Since  the  beginning  of  the  European  war  the  financial 
and  banking  systems  of  all  the  principal  countries  have 
been  undergoing  a  period  of  stress  and  trial,  w^hich  has 
resulted  in  many  modifications  of  practice.  No  one  can 
yet  tell  what  will  be  the  conditions  under  which  the  Euro- 
pean banking  institutions  will  emerge  from  the  war  or 
what  modifications  in  their  methods  will  be  necessitated 
either  temporarily  or  permanently  as  the  result  of  war 
needs  and  conditions.  That  there  will  be  such  modifica- 
tions no  one  can  question.  In  the  meantime  the  experi- 
ence of  the  various  countries  in  financing  their  needs  and 
in  adjusting  the  banking  machinery  so  as  to  harmonize 
with  new  requirements  is  proving  one  of  the  most  inter- 
esting chapters  of  financial  history  of  recent  years.  War 
necessities  have  made  foreign  governments  reticent 
about  making  known  the  detailed  facts  as  to  some  of  the 
principal  financial  questions  and  conditions  now  prevail- 
ing, so  that  only  a  general  analysis  and  discussion  can  be 
devoted  to  them.  In  brief  form,  however,  it  will  be 
endeavored  to  indicate  the  main  elements  in  what  has 
been  done. 

The  Bank  of  England 

Among  foreign  banks,  that  which  conspicuously  inter- 
ests American  students  is  the  Bank  of  England,  and  the 
system  of  banking  that  has  been  built  up  around  it.  Char- 
tered in  1694,  the  Bank  of  England  in  its  life  of  more  than 
two  hundred  years  has  gradually  become  the  basis  of 
government  finance  and  the  mainstay  of  private  financial 
business  operations  in  Great  Britain.  From  time  to  time 
modifications  have  been  introduced  by  law  into  the  char- 


302  American  Banking 

ter  or  regulations  by  wliich  the  institution  is  controlled, 
but  today  it  rests  primarily  upon  the  Bank  Act  of  1844. 

The  Bank  of  England  is  essentially  a  great  government 
institution  owned  by  private  individuals  which  controls 
and  supplies  the  note  circulation  and  which  is  practically 
divided  into  two  departments,  one  called  the  Issue 
Department,  the  other  the  Banking  Department,  whose 
functions  are  sufficiently  indicated  in  a  general  way  by 
their  names.  The  issue  department  under  the  Act  of 
1844  was  authorized  to  issue  notes  only  upon  government 
securities  or  coin  or  bullion  to  an  equal  amount  held  as  a 
backing.  It  was  provided  that  the  amount  of  notes  issued 
on  securities  should  not  exceed  £14,000,000  (about 
$70,000,000)  while,  above  this,  additional  issues  were  to 
rest  on  coin  or  bullion.  However,  the  other  banks  of 
issue  which  then  existed  in  England  were  to  lose  their 
power  of  issue  in  the  event  that  they  should  cease  at  any 
time  to  continue  their  notes  outstanding.  Under  such 
circumstances,  the  Bank  of  England  was  to  be  allowed 
to  increase  its  issue  based  on  government  bonds  to  the 
extent  of  two-thirds  of  the  country  bank  circulation 
retired.  In  that  way,  about  $20,000,000  has  been  added 
to  the  bond-secured  circulation,  which  is  now  in  the 
neighborhood  of  $90,000,000,^  the  total  notes  in  circula- 
tion being  about  $150,000,000.  The  Issue  Department 
exchanges  notes  for  coin  and  coin  for  notes,  and  if  the 
Banking  Department  wants  notes  it  gets  them  from  the 
Issue  Department,  just  as  any  one  would,  by  depositing 
coin  or  bullion  there. 

In  the  event  of  a  panic  or  crisis,  resulting  in  an  excess 
in  hoarding  of  coin  and  currency  and  the  consequent 
demand  for  more  circulation,  the  government  has  some- 

1  The  figures  given  in  various  places  in  this  chapter  represent  condi- 
tions as  they  existed  before  the  war  brought  about  an  abnormal  situation. 


Banking  in  the  United  States  and  Abroad        303 

times  '^ suspended  the  Bank  Act" — an  operation  which 
was  tantamount  to  permitting  the  bank  to  issue  its  notes 
without  coin,  bullion,  or  government  securities  behind 
them,  simply  on  the  strength  of  the  commercial  paper  it 
might  have  in  its  portfolio.  This  expedient  is  analogous 
to  that  of  clearing-house  certificates  adopted  on  various 
occasions  by  American  banks  as  we  have  already  seen. 

The  Banking  Department  does  a  "straight"  banking 
business  upon  ordinary  short-time  paper.  Its  operations 
have  tended  to  assume  the  character  of  rediscounts,  to 
a  considerable  extent,  and  the  bank  is  now  practically 
the  banker's  bank  of  the  country. 

Although  in  close  relation  with  the  government,  it  is 
a  private  institution.  It  receives  public  deposits  and 
furnishes  a  great  deal  of  fiscal  ser-^dce,  but  theoretically 
it  has  the  same  relation  to  the  government  as  it  does  to 
individuals  and  corporations.  It  is  controlled  by  24 
directors  and  a  governor  and  deputy  governor  serving 
for  one  year. 

Owing  to  the  practice  of  other  banks  in  depositing  their 
reserve  with  the  Bank  of  England,  the  bank  is  practically 
in  control  of  the  gold  supply  of  the  country  and  feels  it 
to  be  a  fundamental  duty  to  adopt  such  measures  as  will 
prevent  gold  from  leaving  the  country  to  any  undue 
extent.  This  it  does  by  raising  the  rate  of  discount  on 
occasion,  the  effect  being  that  a  drain  of  specie  can  be 
checked  and  thereby  the  coin  of  the  country  prevented 
from  going  elsewhere,  pending  a  readjustment  of  busi- 
ness relations  which  will  determine  the  exact  distribution 
of  coin  and  bullion  to  which  the  various  countries  are 
entitled.  The  discount  rate  varies  considerably  from 
time  to  time,  the  average  running  from  3  per  cent  to  5 
per  cent  and  occasionally  reaching  7  per  cent  or  higher. 
These  higher  rates  are  usually  applied  against  the  out- 


304  American  Banking 

side  public  rather  than  against  the  bankers  who  deal 
with  the  institution. 

English  Joint-Stock  Banks 

Around  the  Bank  of  England  have  grown  up  many 
strong  joint-stock  banks  which  stand  in  somewhat  the 
same  relation  to  it  as  do  the  national  banks  of  the  United 
States  to  the  Federal  reserve  banks  of  their  districts, 
save  that  of  course  the  latter  relation  is  far  less  close. 
These  banks  do  business  chiefly  without  much  use  of  note 
currency  other  than  that  furnished  by  the  Bank  of  Eng- 
land, extending  their  accommodations  in  the  form  of 
deposit  credits  against  which  checks  are  drawn.  As 
already  seen,  the  note  currency  includes  no  element  of 
elasticity  and  the  expansion  and  contraction  of  credit 
takes  the  form  entirely  of  additions  to  or  subtractions 
from  the  deposit  account.  Taking  the  banks  of  England 
as  a  whole,  their  deposits,  current  accounts,  and  notes 
outstanding  are  in  ordinary  times  £800,000,000,  their  cap- 
ital being  £68,000,000  and  their  cash,  either  on  hand  or 
available  on  short  notice,  £225,000,000. 

There  has  been  in  recent  years  a  strong  tendency  to 
consolidate  these  banks  and  concentrate  their  operations 
through  the  establishment  of  branch  banks.  Owing  to 
the  practice  of  depositing  mth  the  Bank  of  England, 
these  joint-stock  banks  are  thus  dependent  upon  it  for 
their  solvency  and  look  to  it  to  protect  the  reserve  of  the 
country  through  its  changes  in  the  discount  rate.  The 
joint-stock  banks  are  able  to  do  a  good  deal  of  business 
that  could  not  be  handled  by  the  Bank  of  England,  while 
at  the  same  time  supplying  classes  of  credit  that  are 
needed  by  the  community.  The  process  of  rediscounting 
at  the  bank,  the  proceeds  being  carried  to  the  credit  of 
the  various  banks,  is  especially  active  in  times  of  anxiety 


i 


Bmihing  in  the  United  States  and  Abroad        305 

when  the  whole  country  is  looking  to  the  maintenance  of 
the  Bank  of  England  reserve.  At  such  times  bankers 
having  accounts  do  not  hasten  to  draw  out  gold  and  cur- 
rency as  do  those  in  the  United  States,  but  instead  keep 
the  cash  in  this  central  reserve,  relying  upon  the  govern- 
ment to  permit  the  bank  to  increase  its  issue  of  bank 
notes  in  case  of  extremity. 

Scotch  Banking  System 

Well  worthy  of  notice  in  contrast  with  the  Bank  of 
England  is  the  Scotch  banking  system,  which  includes  a 
considerable  number  of  institutions  operating  inde- 
pendently and  with  relatively  small  capitals.  Their 
characteristic  feature  has  been  found  in  the  elasticity 
and  safety  of  the  bank  notes  they  have  issued,  and  in  the 
power  exhibited  of  drawing  out  the  savings  of  the  com- 
munity and  making  them  active.  At  the  opening  of  the 
European  war  eight  strong  banks  had  outstanding  a  total 
average  circulation  of  about  £7,200,000  or  about  $36,000,- 
000,  against  which  is  held  something  under  £6,000,000  or 
about  $30,000,000  in  specie.  This  amount  of  specie,  how- 
ever, constitutes  the  total  reserve  of  the  banks  and  is 
their  reliance  not  only  for  the  redemption  of  note-liabili- 
ties but  for  meeting  the  deposit  liabilities  as  well. 

The  English  Bank  Act  of  1844,  which  was  extended  to 
Scotland  in  1845,  permitted  the  banks  already  existing  in 
Scotland  to  keep  outstanding  an  authorized  circulation 
equal  to  the  average  during  the  year  ending  May  1, 1845, 
and  above  that  to  issue  as  many  notes  based  on  coin  as 
were  desired.  The  authorized  circulation  of  the  Scotch 
banks  is  now  £2,676,350,  so  that  the  actual  circulation  is 
well  within  the  limit  set  by  the  combination  of  gold  and 
silver  holdings  and  authorized  limit  of  uncovered  circu- 
lation.   Wliereas  the  Bank  of  England  notes  are  not  less 


306  American  Banking 

than  £5  (or  about  $25)  in  denomination,  the  great  bulk  of 
the  Scotch  circulation  is  under  £5.  The  Scotch  banks 
have  consistently  endeavored  to  extend  credit  to  men 
possessing  small  capitals,  or  perhaps  having  little  more 
than  an  assured  business  opportunity,  the  notes  being 
freely  issued  as  a  distinct  loan  of  credit,  rather  than  as 
a  kind  of  currency.  By  using  the  note  issue  freely,  the 
banks  have  been  enabled  to  pay  substantial  interest  upon 
deposits  and  thereby  have  induced  the  growth  of  saving. 
By  paying  interest  on  deposits,  they  stimulate  the  return 
of  the  notes  to  the  banks  as  a  foundation  of  savings 
accounts,  and  thus  the  activity  of  redemption  is  advanced. 

In  a  number  of  ways,  the  Scotch  banks  have  been 
more  serviceable  and  more  inclined  to  eliminate  the 
unnecessary  formalities  of  banking  than  have  the  English 
contemporary  institutions,  and  their  service  to  the  com- 
munity has  been  correspondinglj^  greater.  Particular 
advantage  has  been  derived  by  the  country  from  the  free 
issue  of  notes  subject  to  immediate  redemption  but  \vith- 
out  the  requirement  of  special  security  behind  them. 

The  situation  of  the  Bank  of  England  at  the  opening 
of  the  European  war  in  August,  1914,  was  about  normal, 
there  being  not  only  no  weakness  apparent  but  all  English 
financial  institutions  being  in  an  unusually  satisfactory 
condition.  At  the  outset  of  the  war  it  was  of  course 
desired  to  go  on  pajdng  cash  for  all  banking  obligations 
just  as  had  been  customary  in  the  past.  Panic  and  uncer- 
tainty, however,  were  so  serious  that  practically  the  first 
thing  that  happened  after  the  outbreak  of  the  war  was 
the  establishment  of  what  was  called  a  ''moratorium," 
that  is  to  say,  an  arrangement  under  which  it  was  legally 
enacted  that  creditors  could  not  for  a  certain  specified 
time  claim  payment  of  what  was  due  to  them.  This  would 
not  have  been  necessary  had  the  banks  been  ^villing  to 


Banking  in  the  United  States  and  Abroad        307 

call  loans,  insist  upon  payment,  and  compel  their  debtors 
to  liquidate.  This  policy,  however,  would  have  merely 
passed  on  the  demand  to  other  debtors,  and  a  general 
condition  of  bankruptcy  would  have  ensued.  There  was 
some  withdrawal  of  cash  from  the  Bank  of  England  at 
the  opening  of  the  war,  and  in  consequence  rates  were 
raised  by  the  bank  from  4  per  cent  to  10  per  cent  with 
the  idea  of  preventing  the  creation  of  further  obligations. 
This  measure  had  little  effect  notwithstanding  that  the 
bank,  so  long  as  the  run  was  made,  met  practically  all 
demands  upon  it.  The  stock  exchange  was  promptly 
closed  in  order  to  prevent  a  downward  rush  of  prices,  due 
to  the  effort  of  holders  to  sell  out  and  realize  in  order  to 
avoid  loss  or  get  means  to  pay  creditors. 

In  view  of  the  draft  on  the  banks  after  the  closing  of 
the  stock  excliange  and  other  dangerous  sjauptoms,  the 
Bank  Act,  which  forbids  the  issue  of  bank  notes  except 
under  specified  conditions  as  already  described  above, 
was  suspended  on  August  6  and  government  notes  were 
issued  for  the  purpose  of  meeting  obligations,  these  notes 
being  convertible  into  gold  on  demand.  At  the  same  time, 
the  British  holders  of  claims  on  foreign  countries  insisted 
upon  being  paid,  while  there  was  a  general  interruption 
to  international  trade  due  to  uncertainty  of  travel  on  the 
Atlantic. 

The  moratorium  lasted  until  November  4,  and  the  stock 
exchange  reopened  not  very  long  thereafter.  Meantime 
Great  Britain  had  succeeded  in  obtaining  a  very  large 
amount  of  gold  from  foreign  countries.  The  draft,  how- 
ever, upon  British  resources,  due  to  the  necessity  of  pay- 
ing for  an  excess  of  imports,  subjected  Great  Britain,  as 
the  principal  banking  center  of  Europe,  to  danger  and  led 
to  the  loan  of  $500,000,000  which  w^as  negotiated  in  the 
United  States  in  the  autumn  of  1915.    This  loan  had  been 


308  American  Banking 

preceded  by  the  development  of  adverse  exchange,  which 
was  due  to  the  fact  that  imports  into  Great  Britain 
were  so  heavily  in  excess  of  exports.  Exports  from  the 
United  States  were  so  heavily  in  excess  of  imports  as  to 
create  a  situation  in  which  American  goods  had  to  be  paid 
for  in  credit  or  else  gold  had  to  be  shipped.  Great 
Britain,  however,  like  other  countries,  was  umvilling  to 
pay  more  gold  than  was  absolutely  necessary. 

Sunmiing  up,  the  main  effect  of  the  war,  save  for  the 
moratorium  and  its  attendant  incidents,  has  been  the  cre- 
ation of  government  currency  and  the  development  of 
an  unfavorable  foreign  exchange  situation,  which  must 
be  met  by  prompt  means  of  pajmient  of  foreign  obli- 
gations. 

Bank  of  France 


I 


A  system  widely  different  from  that  of  England, 
although  with  points  of  similarity,  is  seen  in  France.  I 
There  the  Bank  of  France,  organized  in  1803,  performs  ' 
the  same  fiscal  functions  as  does  the  Bank  of  England, 
and  controls  the  specie  reserve  of  the  country  just  as  does 
the  Bank  of  England.  It,  however,  issues  notes  without 
being  required  to  hold  government  securities  behind  them 
and  without  being  subject  to  detailed  dictation  as  to  the  ^ 
amount  of  its  reserve.  The  Bank  of  France  is  owned 
independently  of  the  government,  but  is  closely  super- 
vised by  it.  Its  capital  amounts  to  only  182,500,000 
francs,  entirely  in  private  hands,  but  the  government  is 
allowed  to  appoint  the  governor  and  two  deputy  gov- 
ernors and,  at  the  will  of  the  minister  of  finance,  to 
remove  them  from  office  if  circumstances  seem  to  require. 
Public  moneys  are  received  on  deposit  and  various  fiscal 
services  are  performed,  while  the  bank  has  some  impor- 


BanUing  in  the  United  States  and  Abroad        309 

tant  functions  in  connection  with  the  issue  of  govermnent 
securities  and  the  payment  of  installments  of  interest. 

An  analysis  of  the  accounts  of  the  Bank  of  France 
shows  a  different  state  of  affairs  from  that  which  is 
exhibited  by  the  accounts  of  the  Bank  of  England.  Out 
of  liabilities  of  about  6,000,000,000  francs  on  a  date  prior 
to  the  war,  nearly  5,000,000,000  were  notes  outstanding, 
while  coin  and  bullion  on  hand  aggregated  upward  of 
3,700,000,000  francs.  The  commercial  paper  held  at  that 
time  was  only  about  1,300,000,000  francs  and  deposit 
accounts  of  private  individuals  amounted  to  less  than 
500,000,000  francs. 

These  accounts  point  to  two  important  facts  in  connec- 
tion mth  the  service  performed  by  the  Bank  of  France. 
Its  function,  like  that  of  the  Bank  of  England,  is  very 
largely  that  of  discount,  and  its  operations  of  this  kind 
extend  even  to  very  small  transactions.  Commercial 
paper  of  less  than  100  francs — about  $20 — is  discounted 
in  great  quantities  by  the  bank,  and  there  have  been 
years  when  the  average  value  of  the  paper  discounted 
was  not  much  more  than  700  francs — about  $140.  On  the 
other  hand,  the  immense  volume  of  the  notes  outstanding 
shows  that  the  institution  makes  its  loans  by  the  issue  of 
notes  rather  than  by  the  creation  of  deposit  credits. 
Practice  in  France  differs  in  this  regard  very  radically 
from  that  of  England,  the  population  being  far  less  accus- 
tomed to  the  use  of  checks  and  far  more  favorable  to 
circulating  notes  or  gold. 

Like  the  Bank  of  England,  the  Bank  of  France  has 
assumed  the  duty  of  controlling  the  gold  supply  of  the 
country  by  varying  its  rate  of  discount,  raising  it  when 
there  seems  danger  of  an  undue  loss  and  lowering  it  at 
other  periods.  This  has  been  a  somewhat  easier  task  in 
France  than  in  England  because  of  the  smaller  impor- 


310  American  Banking 

tance  of  Paris  as  a  strictly  financial  and  investment 
center,  as  compared  with  London.  The  Bank  of  France 
has  also  resorted  to  the  plan  of  buj^ing  gold  at  some 
expense,  instead  of  increasing  its  discount  rate  at  times 
when  it  did  not  feel  that  an  advance  in  the  rate,  entailing 
as  this  must  considerable  suffering  upon  commerce  and 
industry,  would  be  wise.  As  in  England,  so  in  France,  a 
structure  of  independent  banking  has  been  built  up 
around  the  Bank  of  France,  that  institution  serving  as  a 
banker's  bank,  just  as  does  the  Bank  of  England. 

France,  like  England,  is,  as  a  rule,  a  creditor  country, 
receiving  ordinarily  more  from  foreign  countries  than 
she  has  to  pay.  At  the  opening  of  the  war  it  is  estimated 
that  there  was  probably  seven  billions  of  francs  in  gold 
in  the  countiy,  four  billions  being  in  the  Bank  of  France, 
and  three  billions  in  the  hands  of  individuals.  At  the 
outbreak  of  the  war  gold  practically  disappeared,  its 
place  being  taken  by  paper,  silver  coin,  and  subsidiary 
money.  In  France,  as  in  Germany,  private  individuals 
have  been  encouraged  to  bring  hoarded  gold  and  to  turn 
it  into  the  reserves  of  the  Bank  of  France.  The  Bank  of 
France  is  not,  technically  speaking,  a  government  bank, 
but  has  always  been  closely  controlled  by  the  government. 
Steady  increase  has  been  made  in  the  amount  of  its  notes 
since  the  beginning  of  the  war,  and  the  increase  in  note 
issues  enables  the  bank  to  make  large  direct  loans  to  the 
government  at  the  same  time  that  it  continues  to  discount 
freely  for  other  banks  and  for  individuals.  Due  to  the 
patriotic  depositing  of  gold  by  French  citizens,  the  stock 
of  gold  in  the  Bank  of  France  has  increased  about  half  a 
billion  francs  since  the  beginning  of  the  war,  notwith- 
standing that  approximately  an  equal  amount  has  been 
paid  to  the  Bank  of  England.  In  France,  as  elsewhere, 
foreign  exchange  has  been  badly  disorganized,  o^\ing  to 


Banking  in  the  United  States  and  Abroad        311 

the  heavy  excess  of  imports  over  exports ;  and  this  will 
continue  to  be  a  more  or  less  marked  condition  until  a 
normal  balance  of  trade  has  been  established,  as  it  may 
be  expected  to  be  when  the  war  is  over,  and  business  sta- 
bility has  been  reintroduced. 

The  Reichsbank 

The  German  Empire  has  developed  a  system  of  bank- 
ing analogous  to  that  of  England  and  France,  though 
dating  only  from  the  period  of  the  formation  of  the  Ger- 
man Empire.  At  that  time  the  Bank  of  Prussia,  which 
had  been  chartered  in  1765,  was  developed  into  the  so- 
called  Reichsbank  or  Bank  of  the  Empire.  By  legislation 
of  1875,  modeled  in  a  measure  after  the  English  Bank  Act 
of  1844,  an  effort  was  made  to  put  the  Bank  of  Prussia 
into  somewhat  the  same  position  as  the  Bank  of  England. 
A  law  passed  in  1873  had  already  provided  that  bank 
notes  should  be  retired  from  circulation  before  the  open- 
ing of  1876  unless  their  denomination  was  expressed  in 
marks,  while  the  smallest  notes  to  be  issued  were  to  be 
for  100  marks  or  about  $23.75. 

The  Act  of  1875  substituted  the  Reichsbank  for  the 
Bank  of  Prussia  and  made  its  capital  120,000,000  marks, 
divided  into  40,000  shares,  while  it  was  directed  that  the 
note  circulation  should  not  exceed  250,000,000  marks 
($60,000,000)  except  under  specified  conditions  presently 
to  be  noted.  This  was  increased  by  successive  steps  to 
472,829,000  marks.  As  in  England  it  was  further  pro- 
vided that  existing  banks  might  retain  their  circulation 
rights,  but  in  the  event  that  they  abandoned  them  they 
were  to  pass  to  the  Reichsbank,  increasing  its  authorized 
issue  t-o  a  corresponding  extent.  It  was  directed  that 
behind  this  authorized  circulation  at  least  one-third  in 
funds  must  be  held,  such  funds  being  money  or  govern- 


312  American  Banking 

ment  bonds,  gold  bullion,  or  foreign  gold  coin.  Above 
the  autliorized  limit,  all  issues  of  notes  were  to  be  backed 
value  for  value  by  protection  of  the  same  description, 
except  under  the  conditions  presently  to  be  noted. 

As  in  the  case  of  the  banks  of  England  and  France,  the 
ownership  of  the  institution  was  left  in  private  hands, 
but  it  was  subjected  to  direct  public  oversight  and  con- 
trol of  a  positive  character.  The  chancellor  of  the 
Empire  is  president  of  the  bank,  while  four  other  mem- 
bers of  a  supreme  council  are  government  nominees,  one 
of  whom  is  named  directly  by  the  emperor.  A  board  of 
directors  controls  the  business  operations,  and  in  this 
board  membership  is  attained  by  government  nomina- 
tion. Another  board  of  commissioners  elected  by  the 
body  of  stockholders  represents  the  private  owners  and 
takes  charge  of  the  routine  business.  Like  the  Banks  of 
France  and  England,  the  Bank  of  Germany  manages 
public  financial  operations,  receives  deposits  of  public 
moneys,  etc. 

The  distinguishing  feature  of  this  bank,  to  which  ref- 
erence has  already  been  made,  is  seen  in  the  special 
provision  for  the  issue  of  bank  notes  over  and  above  the 
authorized  issue  under  certain  specified  conditions.  In 
order  to  meet  the  contingencies  when  there  is  a  specially 
heavy  demand  for  currency,  it  is  provided  that  notes  may 
be  put  out  by  the  bank  over  and  above  the  authorized 
limit,  on  condition  that  the  bank  shall  pay  a  tax  of  five 
forty-eighths  of  one  per  cent  per  week  or  about  5  per  cent 
per  annum  upon  all  such  excess  circulation.  The  excess 
circulation,  moreover,  has  to  be  based  upon  bills  of 
exchange  running  not  over  three  months  and  secured  by 
two  signatures.  Subject  to  these  conditions,  the  Reichs- 
bank  has  sometimes  issued  as  much  as  625,000,000  marks 


Banking  in  the  United  States  and  Abroad        313 

over  and  above  the  authorized  issue.  In  1907,  the  tax 
thereby  necessitated  was  more  than  5,600,000  marks. 

Measures  similar  to  those  employed  in  France  and 
England  for  the  control  of  the  gold  reserve  are  pursued 
by  the  Bank  of  Germany,  which  has  come  to  assume  very 
much  the  same  position  toward  the  other  German  banks 
that  is  occupied  by  the  Banks  of  France  and  England 
toward  the  banking  systems  of  those  countries.  It 
rediscounts  the  paper  presented  to  it  by  the  other  banks, 
and  most  of  the  paper  it  accepts  is  on  extremely  short 
time.  The  notes  issued  are  large  in  volume  because  in 
Germany,  just  as  in  France,  the  habits  of  the  community 
call  for  a  large  volume  of  actual  circulating  currency, 
while  the  use  of  checks,  although  growing,  has  not 
attained  the  same  high  degree  of  development  as  in 
England  or  in  the  United  States. 

At  the  opening  of  the  war  monetary  and  baulking  con- 
ditions in  Germany  were  very  favorable.  Every  effort 
had  been  made  since  1908  to  enable  the  Reichsbank  to 
strengthen  itself  and  to  require  the  various  subsidiary 
banks  to  increase  their  deposits  with  the  Reichsbank  and 
to  curtail  unreasonably  large  lines  of  credit.  Thus  at  the 
beginning  of  August,  1914,  Germany  was  in  a  favorable 
situation.  The  government  had,  however,  prepared  a 
number  of  bills  for  enactment  in  the  event  of  war  and 
these  were  passed  by  the  Reichstag  almost  at  the  outset. 
Of  the  four  principal  measures  thus  adopted  the  first 
made  the  notes  of  the  Reichsbank  lawful  money,  while  the 
government  treasury  notes  were  also  made  lawful  money 
and  their  issue  authorized.  The  treasury  was  relieved  of 
the  necessity  of  redeeming  these  treasury  notes,  while 
the  various  banks  of  the  country  were  permitted  to 
redeem  their  own  notes  with  the  notes  of  the  Reichsbank. 

A  second  measure  was  adopted  in  the  repeal  of  the 


314  American  Banking 

German  Currency  Act  of  1873,  which  provided  that  sub- 
sidiary and  minor  coins  should  be  exchanged  for  gold 
upon  demand.  They  were  now  to  be  redeemed  either  in 
treasury  notes  or  in  notes  of  the  Reichsbank. 

A  third  measure  permitted  the  Reichsbank  to  be 
relieved  of  the  requirement  that  it  must  always  hold  two- 
thirds  of  the  amount  of  its  circulating  notes  in  the  form 
of  double-name  paper,  it  being  permitted  to  discount 
obligations  of  the  government  running  three  months  and 
to  hold  such  obligations  instead  of  commercial  paper 
beyond  its  outstanding  circulation.  Further,  the  tax 
upon  circulating  notes  was  also  repealed. 

A  fourth  law  provided  for  the  establishment  of  special 
"loan  banks,"  which  were  intended  to  extend  credit 
against  collateral  securities.  They  had  no  capital  but 
were  authorized  to  issue  ''loan  bank  notes,"  and  these 
could  be  held  by  the  Reichsbank  as  a  part  of  its  legal 
cash  reserve. 

Summing  up,  it  will  be  seen  that  the  whole  effort  of 
the  German  government  was  to  place  the  country  upon  a 
paper  basis,  to  prevent  gold  from  being  paid  out  or  leav- 
ing the  country,  and  to  abandon  the  idea  of  specie  pay- 
ment. The  result  of  these  measures  has  been  to  prevent 
gold  from  leaving  Germany,  but  inasmuch  as  Germany 
has  been  largely  isolated  from  the  rest  of  the  world 
in  regard  to  trade,  it  is  not  possible  to  say  how  these 
measures  would  have  affected  foreign  exchange — the  true 
test  of  the  effect  of  any  financial  measure  bearing  upon 
the  currency  or  the  status  of  banking  institutions.  There 
was  a  sharp  rise  of  exchange  on  Berlin  in  practically  all 
markets  even  at  the  very  outset  of  the  war,  and  since  then 
the  depreciation  of  German  bonds  and  obligations  in 
foreign  markets  has  shown  that  Germany  is  merely  pass- 
ing through  the  same  experience  as  did  the  United  States 


i 


Banking  in  the  United  States  and  Abroad        315 

during  the  Civil  "War,  when  the  country  was  placed  upon 
a  footing  of  irredeemable  paper,  this  paper  promptly 
depreciating  and  requiring  a  long  period  to  re-establish 
specie  payments.  Germany,  in  other  words,  will  carry  a 
large  part  of  her  war  obligations  in  the  form  of  paper 
currency  and  this,  in  spite  of  the  drastic  measures  to  pre- 
vent the  increase  of  prices,  has  greatly  depreciated,  while 
the  banks  (although  not  losing  their  gold)  have  suffered 
in  other  ways  through  the  tremendous  accumulation  of 
irredeemable  paper  and  the  enormous  amount  of  their 
loans  to  the  government,  either  direct  or  indirect. 

Canadian  Banking  System 

A  strikingly  different  system  as  compared  with  those 
already  studied  is  seen  in  Canada  where,  instead  of  a 
single  central  institution  surrounded  by  a  group  of 
smaller  institutions  leaving  their  reserve  with  it  and  rely- 
ing upon  the  central  bank  for  rediscounts  and  for  a 
supply  of  notes,  there  has  grown  up  a  system  of  tolerably 
strong  chartered  banks,  resting  upon  substantially  the 
same  foundation  and  fairly  comparable  with  one  another. 
In  1908,  there  were  30  banks  with  a  total  capital  of  some 
$96,000,000,  the  notes  outstanding  amounting  to  about 
$67,000,000  and  discounts  to  about  $549,000,000.  The 
essential  feature  of  the  Canadian  system  is  seen  in  the 
perfect  freedom  of  issue,  subject  only  to  general  restric- 
tions, which  is  accorded  to  the  banks  and  the  special 
system  of  securing  the  notes  by  means  of  a  joint  guaran- 
tee, or  safety,  fund. 

Under  the  Canadian  law,  shareholders,  like  those  of 
the  national  banks  of  the  United  States,  are  liable  to  an 
amount  equal  to  the  par  value  of  the  stock  they  hold, 
while  note  holders  are  given  a  first  lien  upon  the  assets 
of  the  bank  in  the  event  of  failure.    Every  bank  is  com- 


316  American  Banking 

pelled  to  contribute  to  the  bank  circulation  redemption 
fund,  which  is  maintained  at  a  sum  equal  to  5  per  cent  of 
the  average  circulation  of  each  bank  contributing  thereto. 
This  fund  is  kept  in  the  hands  of  the  minister  of  finance, 
and  in  the  event  of  a  bank  failure,  the  notes  of  such  bank 
begin  to  bear  interest  at  6  per  cent  per  annum  from  the 
time  of  suspension  to  the  date  set  for  payment.  In  case 
the  redemption  fund  is  inadequate  to  pay  the  notes,  the 
fund  is  drawn  upon  irrespective  of  the  amount  that  the 
given  bank  has  put  in.  In  this  way,  a  strong  system  for 
the  redemption  and  securing  of  the  notes  has  been  estab- 
lished, while  the  comparatively  small  number  of  banks 
makes  it  possible  to  follow  with  considerable  care  and 
accuracy  the  condition  of  each  of  the  institutions.  Occa- 
sionally, there  has  been  a  bank  failure  in  Canada,  but  in 
every  case  the  protection  has  been  entirely  adequate,  the 
notes  remaining  at  par  and  being  easily  disposed  of  for 
investment  purposes,  owing  to  their  bearing  interest  at 
6  per  cent.  Although  it  has  sometimes  been  proposed 
that  the  banks  be  required  to  maintain  a  fixed  minimum 
percentage  of  reserve,  this  idea  has  never  been  put  into 
effect,  but  the  banks  have  been  left  free  to  manage  their 
note  issues  and  their  cash  reserves  as  they  see  fit.  Their 
success  in  meeting  the  needs  of  the  community  has  been 
unusually  great. 

The  Canadian  government,  like  most  other  nations 
involved  in  or  affected  by  the  war,  was  obliged  to  resort 
to  special  measures  of  protection.  Mr.  Fred  W.  Field 
has  sketched  the  policy  of  Canada  as  follows : 

(1)  The  Dominion  government  stood  ready  to  issue 
Dominion  notes  to  such  an  amount  as  was  necessary 
against  securities  deposited  by  the  banks  and  approved 
by  the  minister  of  finance. 

(2)  The  government  authorized  the  chartered  banks 


Bmiking  in  the  United  States  and  Abroad        317 

of  Canada  to  make  payments  in  bank  notes  instead  of  in 
gold  or  Dominion  notes  until  further  official  announce- 
^  ment. 

(3)  TJie  redemption  in  gold  of  Dominion  notes  was 
suspended. 

(4)  The  power  of  issue  of  Dominion  notes  was 
increased  by  providing  that  the  finance  minister  should 
hold  gold  to  the  amount  of  25  per  cent  of  the  Dominion 
notes  issued  up  to  a  total  issue  of  $50,000,000;  and  in 
regard  to  Dominion  notes  issued  in  excess  of  that  amount, 
gold  to  be  held  equal  to  such  excess. 

Comparatively  little  use  has  been  made  of  the  author- 
ity permitting  the  issue  of  Dominion  notes  by  the  gov- 
ernment against  approved  securities.  Less  than  $500,000 
of  such  advances  were  outstanding  at  a  recent  date. 

The  legislation  in  regard  to  Dominion  notes  and  gold 
was  framed  so  that  the  Canadian  supply  of  gold  could  be 
held  against  foreign  demands.  This  followed  the  policy 
of  British  banks  and  those  of  other  countries.  It  was 
specified,  however,  that  the  total  amount  of  the  notes  of 
any  bank's  circulation  was  not  to  exceed  at  any  time  the 
amount  of  its  notes  issuable  under  the  provisions  of  the 
Canadian  Bank  Act. 

It  is  under  the  fourth  heading  that  matters  of  chief 
interest  have  happened  in  regard  to  Dominion  notes.  By 
the  special  legislation  there  was  an  integral  change  made 
in  the  Dominion  Notes  Act  whereby  a  margin  of  25  per 
cent  in  gold  might  be  held  in  respect  of  an  issue  of 
$50,000,000  instead  of  $30,000,000  as  under  the  previous 
legislation.  As  regards  denomination,  notes  of  any 
denomination  might  be  issued  to  make  up  this  amount. 
It  may  be  wholly  in  one's,  two's,  or  five's  or  large  legals, 
but  it  will  be  a  combination  of  all. 


318  American  Banking 

Branch  Banking 

Associated  with  the  special  features  of  the  note-issue 
system  of  Canada  is  that  of  branch  banking,  to  which  an 
exceptional  development  has  there  been  given.  Each  of 
the  Canadian  banks  is  authorized  to  establish  branches 
where  conditions  seem  to  demand  it,  and  the  result  has 
been  the  creation  of  more  than  five  hundred  branches 
scattered  throughout  the  country.  These  branches  loan 
the  notes  issued  by  the  parent  institutions  to  agricultur- 
ists and  others  who  prefer  their  credit  in  this  form  rather 
than  in  that  of  deposit  accounts.  The  great  number  of 
the  branches  makes  it  possible  to  distribute  the  notes 
widely,  and  also  to  arrange  for  their  prompt  retirement, 
while  the  relation  of  the  branches  to  the  parent  institu- 
tions has  the  effect  of  distributing  the  capital  of  the 
country  in  a  way  that  makes  it  possible  to  adjust  the 
rate  of  discount  by  a  comparison  of  the  total  banking 
capital  with  the  total  demand  for  bank  accommodation. 

The  effect  of  this  general  distribution  of  capital  and 
accommodation  has  been  to  make  the  rate  of  discount 
very  much  more  even  than  it  has  been  heretofore  in  the 
United  States.  Thus,  in  the  remote  parts  of  Western 
Canada,  the  rate  of  discount  is  seldom  more  than  1  or 
2  per  cent  higher  than  in  the  cities  of  the  east  (sup- 
posing equally  good  security  to  be  offered  as  a  basis  for 
the  loan),  while  in  the  United  States  on  first-class  secur- 
ity the  rate  of  interest  may  have  been  12  to  15  per  cent 
in  Texas  as  against  4  in  New  York.  Such  ability  to 
get  accommodation  when  entitled  to  it  is  highly  impor- 
tant in  the  development  of  the  newer  portions  of  the 
country.  Canada's  banking  system  has  been  an  impor- 
tant factor  in  the  cheap  and  rapid  moving  of  the  crops 
and  in  the  upbuilding  of  the  manufacturing  business  of 
the  country. 


Banking  in  the  United  States  and  Abroad        319 

Brandi  banking  systems  are  found  in  practically  all 
countries  at  the  present  time.  The  possible  development 
'>  of  such  a  system  in  the  United  States  will  be  watched 
with  great  interest.  In  England,  France,  Germany  and 
elsewhere,  branch  banking  has  attained  a  large  develop- 
ment, but  it  is  in  Canada  that  the  most  valuable  light  is 
thrown  by  the  branch  system  upon  the  question  what 
might  be  expected  from  branch  banking  if  it  is  to  be 
effectually  introduced  in  our  own  country,  and  this  is  the 
reason  for  regarding  the  branch  system,  from  our  stand- 
point, as  a  specially  Canadian  development. 

Other  Banks 

Reverting  for  a  moment  to  European  conditions, 
numerous  strong  central  institutions  well  worthy  of  study 
may  be  observed.  Among  these  may  be  mentioned  the 
Austro-Hungarian  Bank,  the  Bank  of  Russia,  the 
National  Bank  of  Belgium,  the  Bank  of  the  Netherlands, 
and  various  others.  In  America,  the  banks  of  Mexico, 
among  them  the  Central  Bank  of  Mexico,  afford  some 
interesting  lessons.  In  South  America  more  or  less  suc- 
cess has  been  had  in  the  several  Latin  Republics  in 
organizing  systems  of  their  oa\ti,  in  some  of  which  a 
Central  National  Bank  plays  a  part  similar  to  that  of  the 
chartered  banks  of  Europe,  while  others  are  organized 
on  a  plan  distantly  resembling  the  national  banking 
system  of  the  United  States.  Thus  far  there  are  com- 
paratively few  lessons  to  be  draA\Ti  for  our  o^vn  use  from 
the  South  American  banks. 

Principal  Types  of  Banks 

Reviewing  the  experience  of  modern  countries  with 
banking,  we  may  fairly  say  that  three  great  types  of 
banking  systems  are  now  conspicuously  before  the  world. 


320  American  Banking 

One  of  these  is  the  system  best  typified  by  the  national 
banking  system  of  the  United  States,  that  of  independent 
banks  varying  in  size,  issuing  notes  either  with  or  without 
special  security  behind  them,  organized  under  uniform 
conditions  at  the  will  of  the  individuals  who  desire  to 
engage  in  the  business,  and  controlled  more  or  less  rigidly 
through  a  system  of  government  inspection  and  over- 
sight. 

A  second  system  is  best  exemplified  in  Canada  where, 
as  already  seen,  the  banks  are  chartered,  are  compara- 
tively few  in  number,  but  are  kept  in  competition  with 
one  another  by  a  power  to  organize  branches  freely  while 
bound  to  one^nother  in  respect  to  note  issues  through  a 
joint  obligation  to  maintain  the  soundness  of  the  note 
currency  by  a  safety,  or  guaranty,  fund. 

A  third  system  is  that  exemplified  by  the  Bank  of 
England,  where  one  conspicuously  strong  institution 
stands  in  close  relations  to  the  government  Treasury, 
acts  as  fiscal  agent,  issues  notes  under  specified  condi- 
tions, protects  the  reserve  of  the  country,  holds  the  funds 
of  other  banks,  rediscounts  for  those  other  banks,  and 
generally  exercises  a  controlling  and  modifying  influence 
besides  carrying  on  the  international  financial  affairs  of 
the  country.  As  we  have  seen,  banks  of  this  latter  type 
may  be  required  to  protect  their  notes  by  a  special  class 
of  security  as  in  the  case  of  England,  and  in  a  lesser 
degree  in  Germany,  or  may  be  left  to  manage  their  note 
issue  as  they  see  fit,  as  in  the  case  of  the  Bank  of  France. 

Along  these  three  lines,  the  banking  systems  of  the 
world  are  developing,  but  they  are  not  developing  at  the 
same  rate  of  speed  or  even  parallel  with  one  another.  On 
the  contrary,  there  are  some  features  in  modern  banking 
that  may  be  regarded  as  the  distinct  outgro^\i;h  of  past 
experience  and  as  having  proved  their  worth.    These  ele- 


Banking  in  the  United  States  and  Abroad        321 

ments  will  undoubtedly  be  recognized  and  adopted  in  the 
banking  systems  of  the  future,  and  they  will  necessarily 
be  adopted  by  those  nations  which  seek  to  put  their  bank- 
ing systems  upon  a  foundation  that  will  be  of  greater 
service  to  their  citizens.  Without  attempting  to  speak 
too  positively  on  this  head,  we  may  safely  indicate  a  few 
such  features  as  those  that  will  be  of  growing  importance 
henceforth. 

Chaeactekistics  of  Modeen  Banking  Systems 

The  idea  of  combination  of  bank  reserves  has  undoubt- 
edly won  its  way  to  the  front  and  will  be  more  and  more 
accepted  as  time  goes  on.  Such  combination  of  reserves 
does  not  call  necessarily  for  the  creation  of  a  central 
bank.  It  means  simply  the  joint  exercise  of  oversight 
and  control  of  ultimate  resei^^es,  whether  this  is  obtained 
through  the  mutual  check  exerted  by  groups  of  banks 
upon  one  another  or  by  the  spontaneous  recognition  of 
some  one  bank  of  conspicuous  strength  as  the  leader  and 
reserve  holder  of  the  system. 

Another  feature  that  has  found  positive  acceptance  is 
that  of  free,  elastic  note  issue,  the  protection  of  the  notes 
being  left  in  the  hands  of  the  bank  or  banks  by  which 
they  are  issued. 

A  third  feature  of  the  successful  banking  system  is 
seen  in  the  establishment  of  branches  under  conditions 
that  will  sufficiently  protect  honestly  competing  banks, 
but  will  at  the  same  time  render  it  possible  for  banks  to 
supply  the  needs  of  the  community  to  the  fullest  extent. 

Finally,  may  be  mentioned  as  an  unquestionable  neces- 
sity in  the  suitable  rounding  out  of  a  banking  system,  the 
establishment  of  proper  relationships  between  the  gov- 
ernment treasury  and  the  system  in  such  a  way  as  fully 
to  safeguard  the  community  against  excessive  withdraw- 


322  American  Banhing 

als  of  coin  or  currency  into  the  government  vaults  and  in 
such  a  way  as  to  relieve  the  government  from  the  neces- 
sity of  helping  individual  banks  from  time  to  time  when 
they  have  run  into  difficulty  as  a  result  of  careless  or  too 
extensive  operations. 

In  testing  any  banking  system,  it  is  therefore  neces- 
sary to  inquire  how  far  it  conforms  to  these  general  ideas 
and  how  far,  if  it  does  not  conform  to  them,  it  is  capable 
of  being  remodeled  in  a  way  that  will  bring  it  into  more 
or  less  harmony  with  them.  It  should  be  repeated  that 
the  application  of  these  ideas  is  not  the  same  in  every 
country.  Differences  in  the  development  and  upbuilding 
of  their  business  systems  call  for  different  methods  of 
applying  similar  principles. 


TEST  QUESTIONS 

1.  Wliat   are   the   essential  characteristics  of  the   Bank   of 
England? 

2.  Explain   the   process  by   means   of  which  the  Bank   of 
England  controls  the  gold  supply  of  the  nation. 

3.  Wliat  is  the  nature  and  organization  of  the  English  joint- 
stock  banks? 

4.  What  are  the  distinguishing  characteristics  of  the  Scotch 
banking  system? 

5.  Explain   the   organization   of   the   Bank   of  France   and 
show  its  relation  to  the  govennnent. 

6.  Explain  the  organization  of  the  Reichsbank.     "What  spe- 
cial powers  are  given  to  the  Reichsbank  over  the  issue  of  notes? 

7.  What  are  the  essential  features  of  the  Canadian  banking 
system  ? 

8.  What  are  the  three  chief  types  of  modern  bank  systems? 
Give  examples  of  each. 


CHAPTER  XXI 

PROBLEMS  OF  AMERICAN  BANKING 

It  may  be  expected  that  during  the  next  few  years  the 
development  of  banking  in  the  United  States  will  center 
very  largely  around  the  application  of  the  Federal 
Reserve  Act,  its  modifications,  where  such  modifications 
prove  to  be  necessary,  its  adaptation  to  conditions,  and 
the  adjustment  of  the  national  banking  laws  to  it.  It  is, 
therefore,  worth  while  to  review  in  brief  outline  some  of 
the  main  and  essential  features  which  will  call  for  atten- 
tion in  these  connections. 

Question  of  Crises  and  Panics 

As  has  been  seen  at  an  earlier  point  in  this  discussion, 
one  of  the  conditions  which  most  directly  gave  rise  to  the 
federal  reserve  system  was  the  fact  of  recurring  crises 
and  panics,  which  threw  the  business  world  into  con- 
fusion and  entailed  disaster  upon  the  community.  It 
was  undoubtedly  a  prime  object,  if  not  the  primary 
object,  of  all  measures  of  banking  reform,  to  terminate 
the  dangers  involved  in  such  conditions  and  to  provide  a 
means  of  safeguarding  the  national  business  interests 
against  such  occurrences. 

The  Federal  Reserve  Act,  like  other  proposed  meas- 
ures of  banking  reform,  has  this  problem  fully  in  view. 
It,  however,  deals  with  the  question  in  a  way  that  differs 
from  many  of  the  bills  which  have  preceded  it.  The  cen- 
tral  thought   of  the   Federal  Reserve   Act  is   that   of 

323 


924  American  Banking 

strengtheuing  the  banking  system  of  the  United  States 
in  such  a  way  as  to  forestall  crises  and  panics  by  correct- 
ing the  conditions  which  lead  to  the  development  of  such 
dangers.  To  this  end,  the  act  provided  for  open-market 
operations,  which  were  intended  to  give  to  the  banks  tho 
power  to  go  into  the  market,  and  by  bujdng  paper  or 
selling  what  they  already  held,  as  the  case  might  be,  to 
exercise  a  regular  and  powerful  control  over  rates  of 
discount  by  applying  a  check  to  undue  tendencies  to  an 
increase,  and,  at  the  same  time,  by  affording  a  stimulus 
when  the  opposite  situation  rendered  action  necessary. 

This,  it  will  be  seen,  is  a  radically  different  idea  from 
that  which  led  to  the  selection  of  an  emergency  or  panic 
relief  measure,  which  furnished  a  means  simply  of  help- 
ing hard-pressed  banks  when  dangerous  conditions  had 
already  made  themselves  manifest.  To  apply  the  Fed- 
eral Reserve  Act  in  this  aspect  it  will  be  necessary  to 
develop  American  banking  along  the  lines  marked  out  by 
European  experience  and  to  educate  the  banking  com- 
munity to  the  view  that  federal  reserve  banks  may  be 
expected  to  compete  with  them  freely  whenever  such 
action  is  for  the  best  interests  of  the  community. 

This  thought  is  worthy  of  considerably  greater  elabo- 
ration. Many  persons  have  held  from  the  beginning  that 
it  was  not  desirable  to  attempt  to  establish  an\ihing  more 
than  provision  for  exceptional  and  unusual  conditions  in 
the  United  States  and  that,  therefore,  we  could  safely 
content  ourselves  with  legislation  providing  for  emer- 
gency currency  or  emergency  treatment  of  banking  needs. 
This  was  the  underlying  idea  of  the  Aldrich-Vreeland 
Law,  a  law  which,  after  Ijdng  dormant  for  some  years 
and  being  amended,  served  a  valuable  purpose  during 
the  stringency  of  1914.  It  was  supposed  by  many  per- 
sons when  the  Federal  Reserve  Act  was  passed  that  the 


i| 


f 


Problems  of  American  Banking  325 

federal  reserve  banks  had  been  recognized,  not  as  emer- 
gency banks,  but  as  permanent  aids  to  sound  finance  in 
the  United  States,  the  co-operative  expression  of  the  best 
sense  of  the  banking  community  upon  general  conditions 
affecting  all  bankers  in  greater  or  less  degree,  and,  as 
such,  acceptable  to  all.  Now  that  there  has  been  some 
experience  in  the  operation  of  the  federal  reserve  banks, 
the  older  question  is  reappearing  in  a  new  form. 

How  Reserve  Banks  Meet  the  Situation 

The  question  is  directly  raised  whether  federal  reserve 
banks  should  be  active  institutions,  playing  a  direct  part 
in  the  financial  life  of  the  community,  or  whether  they 
should  be  sporadic  and  occasional  in  operation,  called 
into  play  only  when  necessity  requires.  This  question 
may  be  discussed  from  two  standpoints.  We  may  con- 
sider what  the  act  itself  has  provided,  and  what  effect  it 
is  wise  and  desirable,  from  the  standpoint  of  banking 
theory,  that  it  should  have  upon  others  than  those  who 
are  charged  with  its  administration. 

The  Federal  Reserve  Act  is  clear  and  unmistakable  on 
the  first  point.  It  .provides  for  rediscounts  to  member 
banks  as  the  first  and  primary  function  of  the  federal 
reserve  institutions.  But  it  also  provides  for  what  are 
called  ''open-market  operations,"  the  latter  to  be 
engaged  in  at  the  will  of  a  reserve  institution  and  as  con- 
ditions seem  to  dictate.  "What  was  the  object  of  the 
framers  of  the  act  in  making  this  provision?  There  can 
be  no  doubt  as  to  their  essential  purpose.  They  recog- 
nized that  there  would  probably  be  times  when,  through 
lack  of  rediscount  offerings,  the  banks  would  be  unable 
to  exert  that  direct  effect  upon  the  market  which  would 
be  necessary  if  they  were  to  perform  their  full  function 
as  holders  of  the  ultimate  reserves  of  the  country.    It 


326  American  Banking 

was  the  intejition  of  the  Federal  Reserve  Act  to  provide 
a  means  whereby  the  banks  could  make  their  rates  of  dis- 
count effective  in  the  same  sense  in  which  that  operation 
is  performed  by  foreign  banking  institutions,  such  as  the 
Banks  of  England  and  France.    It  was  intended  to  vest 
them  with  the  authority  both  to  buy  and  sell  from  per- 
sons, firms,  corporations,  and  banks,  other  than  their    | 
own  stockholders,  in   order  that  at  times  they  might   ^ 
extend  the  benefits  of  their  discounting  power  to  non- 
members  or  in  order  that  they  might  make  provision  \\ 
against  contingencies  of  the  future,  which  member  banks, 
although  perfectly  aware  of,  were  prevented  from  pro- 
viding for  by  the   exigencies   of  competition.     It  was 
intended  that  they  should  compete  with  member  banks  J 
or  with  members  of  other  federal  reserv^e  banks,  if  occa- 
sion demanded  it,  for  the  obvious  reason  that  only  by  so 
doing  could  they  in  the  highest  degree  serve  both  the 
interests  of  the  public  and  that  of  the  banking  community 
as  a  whole,  which,  in  the  best  sense,  is  sjTionymous  with 
that  of  the  public. 

And  in  this  view  of  the  functions  of  the  federal  reserve 
banks,  the  Federal  Reserve  Act  based  itself  firmly  upon 
experience.  There  are  no  banking  institutions  in  for- 
eign countries  which  deal  only  with  banks  and  are  cut  off 
from  any  communication  with  others.  Either  by  direct 
dealing  with  the  public  at  large  and  the  continuous  dis- 
counting of  paper  irrespective  of  its  amount,  provided  it 
conforms  to  certain  other  requirements,  or  by  direct  deal- 
ing with  specific  classes  of  makers  or  owners  of  commer- 
cial paper,  these  banks  exert  the  weight  of  their  influence 
in  the  market,  and  do  what  they  can  to  stabilize  gold  , 
movements,  render  rates  of  discount  uniform  and  fair 
to  all,  and  at  the  same  time,  make  provision  against 


Problems  of  American  Banking  327 

future-  market  developments  that  might  otherwise  be  left 
to  work  themselves  out  according  to  circumstances. 

When  the  Federal  Resei-^^e  Act  was  first  taken  under 
consideration,  it  was  suggested  in  influential  quarters 
^  that  the  banks  be  given  power  to  receive  deposits  from, 
and  deal  directly  with,  individuals.  The  matter  was  care- 
:  fully  considered,  and,  for  a  variety  of  reasons,  it  was 
.  not  deemed  wise  to  take  this  step.  Later  it  was  suggested 
'  that  the  government  should  practically  supply  the  basic 
funds  and  operate  the  proposed  new  banks  in  order  that 
it  might  fully  and  entirely  control  their  dealings  and 
their  effect  upon  the  market.  This,  also,  after  being  con- 
sidered, was  laid  aside,  and  in  its  place  there  has  been 
substituted  a  system  of  co-operation  between  the  govern- 
ment and  the  banks  in  which  the  latter  have  control  of 
their  own  funds  and  can  do  with  them  as  they  please, 
notmthstanding  that  they  are  recognized  as  being  vested 
with  a  public  interest.  Will  they  recognize  that  these 
funds  are  to  be  used  like  the  reserve  funds  of  foreign 
countries  for  the  purpose  of  bringing  about  a  condition 
of  stability  and  balance  in  the  money  market,  or  will  they 
persevere  rather  in  the  view  that  emergencies  are  to  be 
allowed  to  create  themselves  and  that  on  such  occasions, 
and  then  only,  the  combined  power  of  the  reserves  of  the 
country  is  to  be  brought  into  play  ?  The  question  is  one 
that  must  be  definitely  disposed  of. 

COMPAEISONS    OF   EeSEEVE   BaNKS 

Some  are  fond  of  drawing  analogies  between  federal 
reserv^e  banks  and  reservoirs  of  water,  while  others  com- 
pare them  with  a  set  of  fire  engines,  and  still  others 
choose  to  draw  an  analogy  bet^veen  a  reser\''e  bank  and 
an  extra  dynamo  in  a  power  house.  The  most  correct 
comparison  is  that  which  regards  them  as  being  similar 


328  American  Banking 

to  what  we  know  as  a  bank — the  reserve  bank  is  neither  a 
reservoir,  a  fire  engine,  nor  a  power  house,  but  it  is  a 
bank;  and  in  order  to  do  its  work  with  success  and  to 
give  the  banking  results  which  experience  has  indicated 
as  necessary,  the  reserve  bank  must  work  on  banking 
lines  and  guide  itself  by  banking  principles  in  the  con- 
duct of  its  operations.  It,  in  fact,  differs  in  no  essential 
respect  from  the  best  type  of  bank  as  we  know  it  today, 
save  that  it  lays  special  stress  upon  maintaining  the 
liquidity  of  its  assets.  In  this  connection  the  Federal 
Reserve  Board,  in  its  first  annual  report,  made  the  fol- 
lowing statement : 

It  should  not,  however,  be  assumed  that  because  a  bank  is  a 
reserve  bank  its  resources  should  be  kept  idle  for  use  only  in 
times  of  difficulty,  or,  if  used  at  all  in  ordinary  times,  used 
reluctantly  and  sparingly.  Neither  should  it  be  assumed  that 
because  a  reserve  bank  is  a  large  and  powerful  bank  all  its 
resources  should  be  in  use  all  the  time  or  that  it  should  enter 
into  keen  competition  with  member  banks,  distributing  accom- 
modation with  a  free  and  lavish  hand  in  undertaking  to  quicken 
unwisely  the  pace  of  industry.  Such  a  policy  would  be  sure, 
sooner  or  later,  to  invite  disaster.  Time  and  experience  will 
show  what  the  seasonal  variations  in  the  credit  demands,  and 
what  facilities  in  each  of  the  reserve  banks  of  the  several  dis- 
tricts will  be,  and  when  and  to  what  extent  a  reserve  bank  may, 
without  violating  its  special  function  as  a  guardian  of  banking 
reserves,  engage  in  banking  and  credit  operations.  The  reserve 
banks  have  expenses  to  meet,  and  while  it  would  be  a  mistake 
to  regard  them  merely  as  profit-making  concerns  and  to  apply 
to  them  the  ordinary  test  of  business  success,  there  is  no  reason 
why  they  should  not  earn  their  expenses,  and  a  fair  profit  be- 
sides, without  failing  to  exercise  their  power  functions  and 
exceeding  the  bounds  of  prudence  in  their  management.  More- 
over, the  reserve  banks  can  never  become  the  leading  and  impor- 
tant factor  in  the  money  market  which  they  were  designed  to 


Problems  of  American  Banking  329 

be  unless  a  considerable  portion  of  their  resources  is  regularly 
and  constantly  employed. 

This  statement  covers  the  ground  and  clearly  sets  forth 
the  purposes  of  the  Reserve  Act.  The  functions  of  the 
reserve  banks  may  be  summed  up  in  Biblical  language  by 
suggesting  that,  while  the  bank  must  be  in  the  world,  it 
does  not  need  to  be  of  the  world ;  that  is  to  say,  if  it  is  to 
be  of  service,  it  cannot  withdraw  itself  like  a  financial 
hermit  from  the  ordinary  run  of  transactions.  Neither 
can  it  be  guided  by  the  profit-making  spirit  and  subor- 
dinate every  other  policy  to  that  of  the  making  of  divi- 
dends. It  is  the  ^\^se  and  safe  middle  course  that  the 
reserve  bank  must  follow  and  through  which  it  will  attain 
its  highest  usefulness. 

Relations  to  State  Banks 

The  question  how  successfill  the  federal  reserve  sys- 
tem will  ultimately  be  will  depend  in  some  measure  upon 
the  degree  in  which  it  is  able  to  enlist  the  co-operation 
and  active  support  of  state  banks.  At  the  present  time 
thirty  such  institutions  are  members  of  the  federal 
reserve  system,  and  the  movement  of  state  banks  into 
the  system  is  slow,  although  there  has  been  a  rapid 
enlargement  of  the  number  of  national  banks  partly 
through  the  conversion  of  state  banks  into  national  insti- 
tutions since  the  system  was  first  established. 

Admittance  of  State  Banks 

The  Federal  Reserve  Act  provides  very  liberal  regu- 
lations under  which  state  banks  may  become  members  of 
the  system  and  may  withdraw  practically  at  pleasure, 
subject  to  very  reasonable  limitations  and  restrictions. 
Under  this  regulation  the  principal  elements  requiring 


330  American  Banking 

notice  in  connection  with  the  membership  of  state  banks 
are  here  summarized; 

Any  ehgible  state  bank  or  trust  company  may  make  appli- 
cation to  the  federal  reserve  agent  of  its  district  for  an  amount 
of  capital  stock  in  the  federal  reserve  bank  of  such  district  equal 
to  6  per  cent  of  the  paid-up  capital  stock  and  surplus  of  such 
state  bank  or  trust  company. 

Upon  receipt  of  the  application  the  federal  reserve  agent 
obtains  the  approval  of  his  Board  for  the  application  and  trans- 
mits it  to  the  Federal  Reserve  Board  with  its  report  and  recom- 
mendations. 

In  passing  upon  an  application  the  Federal  Reserve  Board 
considers  especially : 

(1)  The  financial  condition  of  the  applying  bank  or  trust 
company  and  the  general  character  of  its  management. 

(2)  Whether  the  nature  of  the  powers  exercised  by  the  said 
bank  or  trust  company  and  its  charter  provisions  are  consistent 
with  the  proper  conduct  of  the  business  of  banking  and  with 
membership  in  the  federal  reserve  bank. 

(3)  "Whether  the  laws  of  the  state  or  district  in  which  the 
applying  bank  or  trust  company  is  located  contain  provisions 
likely  to  interfere  with  the  proper  regulation  and  supervision 
of  member  banks. 

If,  in  the  judgment  of  the  Federal  Reserve  Board,  an 
applying  bank  or  trust  company  conforms  to  all  the  require- 
ments of  the  Federal  Reserve  Act  and  these  regulations,  and  is 
otherwise  qualified  for  membership,  the  Board  will  issue  a  cer- 
tificate of  approval. 

Every  state  bank  or  trust  company  while  a  member  of  the 
federal  reserve  system  retains  its  full  charter  and  statutory 
rights  as  a  state  bank  or  trust  company  and  may  continue  to 
exercise  the  same  functions  as  before  admission,  except  as  pro- 
vided in  the  Federal  Reserve  Act  and  the  regulations  of  the 
Federal  Reserve  Board,  including  any  conditions  embodied  in 
the  certificate  of  approval.  Such  an  institution,  however,  is 
required  to: 


Problems  of  American  Banking  331 

1.  Invest  only  in  loans  on  real  estate  or  mortgages  of  a  char- 
acter and  to  an  extent  which,  considering  the  nature  of  its  lia- 
bilities, will  not  impair  its  liquid  condition. 

2.  Adjust,  to  conform  with  the  requirements  of  the  Federal 
Reserve  Act  and  these  regulations,  within  such  reasonable  time 
as  may  be  determined  by  the  Board  in  each  case,  any  loans  it 
may  have  at  the  time  of  its  admission  to  membership  which  are 
secured  by  its  own  stock,  or  any  loans  to  one  person,  firm,  or 
corporation  aggregating  more  than  10  per  cent  of  its  capital 
and  surplus  or  more  than  30  per  cent  of  its  capital,  or  any  real 
estate  loans  which,  in  the  judgment  of  the  Federal  Reserve 
Board,  impair  its  liquid  condition. 

3.  Maintain  such  improvements  and  changes  in  its  banking 
practice  as  may  have  been  specifically  required  of  it  by  the  Fed- 
eral Reserve  Board  as  a  condition  of  its  admission,  and  shall  not 
lower  the  standard  of  banking  then  required  of  it. 

It  is  expected  to  enjoy  all  the  privileges  and  observe  all  these 
requirenfents  of  the  Federal  Reserve  Act  and  of  the  regulations 
of  the  Federal  Reserve  Board  applicable  to  state  banks  and  trust 
companies  which  have  become  member  banks. 

State  banks  and  trust  companies  which  have  accepted  mem- 
bership in  the  system  are  permitted  to  withdraw  on  six  months' 
notice  under  reasonable  prescribed  conditions,  so  that  no  per- 
manent status  results  from  the  action  of  a  state  bank  in  accepting 
membership. 

Advantages  and  Disadvantages  of  Membeeship 

From  tills  it  will  be  seen  that  there  is  no  reason  why 
any  state  bank  may  not  accept  membership  in  the  federal 
reserve  system  with  entire  safety  to  Itelf  and  with  com- 
plete reservation  of  Its  power  to  return  to  Its  former 
status.  What  Is  the  governing  motive  that  ought  to  con- 
trol a  state  bank  In  this  connection?  The  prudent  state 
banker  will,  on  looking  over  the  ground,  probably  reach 
the  conclusion  that  he  need  not  worry  about  an  Imaginary 
fear  that  his  Investments  In  a  federal  reserve  bank  will 


332  American  Banking 

be  non-dividend  paying.  There  are  few  well-informed 
persons  who  doubt  that  federal  reserve  banks  will,  with- 
in a  reasonable  time,  pay  all  dividend  claims  to  their 
stockholders.  The  state  banker  Tvill,  however,  recognize 
that  the  reserve  requirements  of  the  Act  are  likely  to 
involve  him  in  some  expense,  since,  of  course,  he  will 
lose  the  interest  which  he  might  have  got  by  depositing 
his  reserve  money  mth  some  other  bank  at  2  per  cent 
or  3  per  cent  interest. 

As  against  this  it  should  be  remembered  that  the  state 
bank  owes  a  duty  to  the  community  in  keeping  itself 
liquid  and  in  a  safe  position.  In  some  states  the  legis- 
latures have  already  cut  down  reserve  requirements  to  the 
same  level  as  that  fixed  in  the  Federal  Reserve  Act,  but 
only  in  a  few  have  they  fixed  as  a  preliminary  condition 
that  the  state  banks  before  taking  advantage  of  these  re- 
ductions should  join  the  federal  reserve  system.  There 
can  be  no  doubt  that  the  duty  of  the  state  banker  is  to  live 
up  to  the  old  reserve  requirements,  or,  if  he  wishes  to  take 
advantage  of  the  new  ones,  to  enter  the  reserve  system. 
On  this  basis  he  will,  in  most  states,  make  little  sacrifice, 
even  from  the  direct  profit-making  standpoint,  by  joining 
the  system. 

The  state  banker  will  be  likely  to  find  in  many  cases  a 
more  serious  difficulty  in  the  fact  that  there  is  little  use 
in  his  joining  the  system  unless  he  invests  a  certain  pro- 
portion of  his  resources  in  commercial  paper  of  a  redis- 
countable  kind.  Of  course,  good  banking  dictates  that 
he  should  do  this  in  any  event  if  he  has  demand  deposits 
outstanding  to  any  considerable  degree.  If  he  has  no 
demand  deposits  outstanding  and  does  not  do  a  commer- 
cial business,  there  is  no  especial  reason  why  he  should 
join  the  system  at  all.  But  if  he  desires  to  change  his 
style  of  banking  and  so  invest  to  some  extent  in  com- 


Problems  of  American  Banking  333 

mercial  paper  in  order  to  have  rediscountable  assets,  he 
puts  himself  into  quite  a  new  relationship  to  the  bank- 
ing community.  This  means  a  very  considerable  change 
in  the  scope  and  character  of  his  business,  and  one  which 
must  be  an  almost  necessary  concomitant  of  his  accept- 
ing membership  in  the  system.  The  state  banker  who 
looks  over  the  ground  will  also  be  likely  to  find  that  in 
limiting  the  amount  of  his  loans  to  specified  persons  and 
in  coming  within  other  restrictions  of  the  National  Bank 
Act,  he  loses  a  part  of  his  liabilities.  In  all  these  par- 
ticulars he,  however,  will  find  membership  in  the  federal 
reserve  system  conducive  to  his  safety  and  soundness 
as  a  commercial  banker  and  also  tending  to  strengthen 
him  with  the  public. 

There  is  a  good  deal  of  difference  af  opinion  as  to  the 
rate  at  which  state  banks  will  enter  the  system.  Most 
persons  agree  that  a  new  period  of  severe  stringency 
or  difficulty  will  lead  many  to  make  application,  and  that 
once  in,  they  will  remain.  Lacking  such  an  impetus,  it 
is  quite  likely  that  the  movement  into  the  system  will 
be  slow,  the  stronger  and  better  banks  and  trust  com- 
panies gradually  earning  in  as  conditions  favor.  If  an 
effective  clearing  and  collection  system  should  be  intro- 
duced, it  is  the  general  opinion  that  state  banks  will  be 
practically  obliged  to  accept  membership  at  an  early 
date.  Congress  may,  of  course,  take  action  designed 
to  force  them  into  the  system. 

If  the  state  banks  enter  only  slowly,  there  will  be  cor- 
responding retardation  in  the  unification  of  banking 
practices  throughout  the  United  States;  but  there  will 
be  no  reason  why  the  federal  reserve  system  should  not 
efficiently  perform  its  functions,  even  if  no  state  banl^ 
members  should  join  it.  However,  the  attitude  of  the 
Federal  Reserve  Board  at  the  present  time  is  one  of 


334  American  Banking  j 

desire  that  state  banks  should  enter  in  every  case  where 
they  are  strong  enough  and  in  good  condition  and  that 
the  system  should  enlarge  its  usefulness  by  serving  the 
state  banks  just  as  it  does  the  national.  Meantime,  in 
case  it  becomes  necessary  to  do  so,  the  Federal  Reserve 
Act  provides  abundant  authority  for  the  board  to  per- 
mit and  arrange  direct  accommodation  to  the  outside 
banks  if  circumstances  should  demand  it. 

Relations  with  the  Government 

Aside  from  the  possible  extension  of  its  numerical 
strength  in  the  way  already  indicated,  there  is  perhaps 
no  field  within  which  the  reserve  system  may  look  for- 
ward to  a  more  rapid  and  important  expansion  of  func- 
tions than  in  the  performance  of  the  duties  assigned  to 
it  as  fiscal  agent  of  the  government.  At  first  it  was 
not  thought  wise  to  have  the  banks  exercise  this  fiscal 
agency  function  until  they  had  become  fully  organized. 
The  performance  of  this  function  entailed  considerable 
labor  and  expense,  while  with  their  immense  resources 
there  was  no  reason  why  the  banks  should  be  expected 
to  make  a  greater  profit  through  the  use  of  government 
funds  than  at  present.  The  Secretary  of  the  Treasury 
consequently  deferred  action  on  the  fiscal  agency  ques- 
tion until  the  banks  were  a  year  old,  designating  them, 
however,  as  fiscal  agents  at  the  end  of  November,  1915, 
such  designation  becoming  effective  January  1,  1916. 

The  arrangements  thus  far  made  include  merely  the 
.  transfer  of  balances  heretofore  held  by  national  bank 
depositaries  in  the  thirteen  cities  where  federal  reserve 
banks  (and  the  one  branch)  are  located,  to  the  reserve 
banks,  the  aggregate  so  transferred  being  some  $10,000,- 
000.  This,  however,  is  only  a  beginning.  At  the  present 
moment  the  Treasury  at  all  times  has  on  deposit  with 


Problems  of  American  Banking  335 

national  banks  between  $40,000,000  and  $50,000,000. 
Under  the  provisions  of  the  Act  it  is  lawful  to  deposit 
much  more  than  this,  and  it  may  reasonably  be  expected 
that  before  a  great  while  practically  all  the  funds  of 
the  treasury,  except  trust  funds  (the  money  held  behind 
gold  and  silver  certificates,  and  for  other  special  pur- 
poses), will  be  placed  in  the  hands  of  the  reserve  banks. 
Ultimately  it  may  be  supposed  that  the  regular  and 
normal  balances  of  the  government  with  reserve  banks 
will  run  from  $200,000,000  to  $300,000,000. 

The  reserve  banks,  moreover,  have  begun  dealing  in 
government  bonds  under  the  terms  of  the  Act,  and  in 
their  capacity  as  fiscal  agents  the  Treasury  will  be  able 
to  rely  upon  them  to  float  any  future  loans  of  which  it 
may  stand  in  need  and  generally  to  take  charge  of  busi- 
ness relations  between  it  and  the  community.  The  Treas- 
ury can  draw  checks  upon  reserve  banks,  and  when  the 
clearing  system  has  been  fully  developed,  these  checks 
will  be,  of  course,  cashable  through  any  member  bank 
at  par.  In  the  same  way  it  will  be  possible  for  the 
Treasury  to  transmit  funds  collected  at  any  point  to  the 
reserve  bank  of  that  district  by  simply  depositing  them 
in  a  local  member  bank  and  ordering  the  transfer  made 
to  its  credit  on  the  books  of  the  reserve  bank  through 
the  clearing  process.  In  this  way  when  the  system  has 
been  fully  developed,  the  present  fiscal  system  of  the 
government  will  be  changed  from  the  placing  of  isolated 
and  independent  cash  carried  in  government  vaults  or 
held  in  depositaries  against  a  pledge  of  United  States 
bonds,  to  a  system  employing  modern  banking  methods 
and  relying  upon  the  check  and  deposit  method  of  pay- 
ment, while,  at  the  same  time,  insuring  the  retention  of 
its  funds  in  commercial  channels  at  all  times. 

This  change  cannot  be  instantaneously  made,  but  will 


336  American  Banking 

require  some  time  to  work  out.  When  it  has  been  fully 
worked  out,  it  will  bring  about  a  general  service  to  the 
government  and  the  banks;  but  the  principal  advantage 
will  accrue  to  the  commercial  public  which  will  find  itself 
relieved  of  the  pressure  which  it  feels  when  heavy  with- 
drawals of  government  funds  are  made  during  periods 
of  stringency. 

Relations  with  the  Treasury  Department 

Under  the  new  system  relations  between  the  federal 
reserve  system  and  the  Treasury  Dej^artment  mil  neces- 
sarily be  of  increasing  vitality  and  importance.  In  the 
original  draft  of  the  Federal  Reserve  Act  it  was  pro- 
vided that  deposits  of  funds  belonging  to  the  govern- 
ment should  be  made  in  reserve  banks  entirely  under 
the  discretion  and  direction  of  the  Reserve  Board  itself, 
and  should  be  withdrawn  or  shifted  in  the  same  way. 
The  final  draft  of  the  law  left  this  power  of  deposit  en- 
tirely in  the  hands  of  the  secretary  of  the  treasury,  while 
it  further  provided  that  the  secretary  might,  at  his 
discretion,  continue  to  deposit  in  national  banks  if  he 
saw  fit.  Under  existing  conditions,  therefore,  close  co- 
operation between  the  Federal  Reseiwe  Board  and  the 
Secretary  of  the  Treasury  in  connection  with  the  man- 
agement of  public  deposits  will  be  essential. 

It  is  to  be  assumed  that  if  the  reserve  banks  render 
efficient  service  to  tlie  Treasury  Department,  as  it  may 
be  expected  that  they  will,  the  Secretary  of  the  Treasury 
will,  in  the  manner  described  above,  shift  practically 
all  his  free  funds  into  them.  The  only  exception  to  this 
general  statement  will  be  found  in  those  cases  where  he 
deems  it  wise  to  continue  to  use  national  banks  as  de- 
positaries because  of  the  greater  convenience  involved 
in  so  doing,  or  because  of  the  existence  of  some  special 


Problems  of  American  Banking  337 

and  local  reason  for  such  use.  There  is  no  reason  to  sup- 
pose that  such  considerations  will  be  very  frequent  or 
numerous.  In  the  main  the  funds  will  undoubtedly  go 
into  the  federal  reserve  banks  except  so  far  as  it  may 
be  thought  that  a  certain  minimum  supply  of  cash  should 
perhaps  always  be  held  by  the  Treasury  Department  in 
its  vaults. 

Just  here  it  should  be  observed  that  in  times  past  the 
Secretary  of  the  Treasury's  motive  for  depositing  in 
national  banks  has  been  not  only  that  of  providing  for 
his  own  convenience  and  that  of  disbursing  officers,  but 
also  that  of  promoting  the  safety  of  the  members  of  the 
system  by  providing  them  with  funds  when  they  were 
hard  pressed.  A  special,  and  at  times,  very  beneficial 
phase  of  this  activity  is  seen  in  the  so-called  ''crop- 
moving  deposits,"  which  have  been  made  by  the  Treas- 
ury from  time  to  time  in  those  parts  of  the  country 
where  money  was  specially  needed  to  assist  in  the  move- 
ment of  the  crops  to  market.  If  the  reserve  banks  fully 
and  effectively  perform  the  duty  of  rediscounting  for 
their  member  banks  whenever  the  latter  are  in  need  of 
assistance,  there  will  be  no  reason  why  government  de- 
posits should  be  placed  with  them  for  any  such  purpose 
hereafter;  on  the  contrary,  the  making  of  such  deposits 
will,  under  ordinary  circumstances,  be  of  doubtful  wis- 
dom. If,  of  course,  a  condition  should  arise  in  which 
a  federal  reserve  bank  was  unable  to  extend  aid  to  a 
member  institution  which  was  entitled  to  such  aid,  in 
the  interest  of  the  community  the  Secretary  of  the  Treas- 
ury might  make  a  special  deposit,  but  it  is  difficult  to  see 
how  such  action  would  benefit  the  member  bank  more 
than  an  equal  amount  of  cash  placed  with  the  federal 
reserve  bank  and  by  it  used  as  the  basis  of  rediscount 
in  behalf  of  the  member  bank.    Gradually,  therefore,  as 


338  American  Banking 

the  system  expands  and  develops,  it  may  be  expected 
that  the  Secretary  of  the  Treasury's  power  of  withdrawal 
will  be  less  and  less  frequently  exercised  and  that  his 
power  of  depositing  with  member  banks  directly  will 
be  called  into  play  only  sporadically. 

There  is  only  one  exception  to  the  proposed  general 
rule  that  at  this  time  appears  likely  to  take  effect.  As 
has  been  seen  in  the  foregoing  treatment  from  time  to 
time,  the  Federal  Reserve  Act  is  based  upon  the  thought 
that  the  resources  of  tlie  several  reserve  banks  can  be 
practically  thrown  together  at  will  by  a  process  of  re- 
discounting  under  the  direction  of  the  Federal  Reserve 
Board.  That  is  to  say,  the  Federal  Reserve  Board,  since 
it  possesses  the  power  of  fixing  a  rate  of  rediscount  be- 
tween federal  reserve  banks  and  of  directing  one  fed- 
eral reserve  bank  to  advance  funds  to  others,  practically 
has  the  power  to  throw  the  resources  of  two  such  banks 
together.  It  is  conceivable  that  a  Federal  Reserve  Board 
might  fix  a  rate  of  discount  so  high  as  to  discourage  such 
aid  at  a  time  when  a  Secretary  of  the  Treasury  thought 
it  was  desirable  or  necessary.  In  such  an  event,  it  may 
be  assumed,  a  Secretary  of  the  Treasury,  by  shifting  de- 
posits from  one  reserve  bank  to  another,  could  supply 
the  needs,  or  what  he  supposed  to  be  the  needs,  of  a 
reserve  bank  and  of  the  community,  without  waiting  for 
the  development  of  rediscounts  under  the  guidance  of  the 
Reserve  Board.  Granted  a  normal  and  reasonable  rate 
of  discount  betAveen  federal  reserve  banks,  it  may  be 
supposed  that  such  a  condition  as  this  would  never 
occur;  but  it  nevertheless  remains  true  that  under  the 
Act  as  it  stands,  the  Secretary  of  the  Treasury  has  at 
all  times  the  power  of  reducing  or  increasing  the  funds 
at  the  disposal  of  any  given  reserve  bank  by  the  simple 
process  of  shifting  the  public  deposits  from  or  to  such 


Problems  of  American  Banking  339 

bank  as  the  case  might  be.  Should  this  action  be  taken 
at  a  time  when  the  amount  available  for  deposit  was 
large,  the  power  exercised  would  be  correspondingly 
large. 

Development  of  Commeecial  Paper 

Thus  far  we  have  spoken  most  largely  of  questions 
relating  to  the  organization  of  the  federal  reserve  sys- 
tem, its  structure  and  membership,  and  the  probable  de- 
velopment thereof  in  the  future.  What  is  likely  to  be 
more  important  in  the  future  work  of  the  system  than 
any  of  these  matters,  however,  is  the  growth  and  change 
resulting  from  real  advance  in  commercial  practice.  The 
Federal  Reserve  Act  recognizes  the  existence  of  many 
kinds  of  commercial  paper  in  the  United  States  and  per- 
mits the  advancing  of  funds  upon  so-called  ''single-name 
paper,"  as  well  as  upon  *' two-name,"  where  the  operation 
to  be  financed  is  a  productive  one.  The  Federal  Reserve 
Board  in  its  regulations  thus  far  has  recognized  this 
state  of  affairs  and  has  provided  for  the  discount  of 
ordinary  single-name  paper,  properly  indorsed  and  pro- 
tected, as  well  as  for  ordinary  bills  of  exchange,  bankers' 
acceptances,  ''commodity  paper"  (that  is  to  say,  paper 
protected  by  receipts  evidencing  storage  of  satisfactory 
kinds  of  marketable  staples,  etc.),  trade  acceptances,  and 
other  varieties  of  paper.  While  all  these  classes  of  paper 
are,  however,  admitted  under  the  terms  of  the  Act,  a 
reading  of  the  statute  makes  it  plain  that  the  law  evi- 
dently contemplates  something  very  different  in  the  future 
development  of  paper — nothing  less  than  the  growth  of 
a  discount  market  for  bills. 

In  the  United  States  a  widespread  practice  of  com- 
mercial settlement,  very  different  from  that  prevailing 
abroad,  has  been  developed.    For  example,  B  may  buy 


340  American  Banking 

goods  from  C  on  90  clays'  time.  C  ** charges"  the  goods 
to  B  on  his  books.  Then  at  the  end  of  90  days  he  bills  the 
goods  to  B,  and  the  latter  pays.  If  B  happens  to  have 
the  funds  to  meet  his  bill  before  the  90  days  are  up,  he 
may  be  allowed  a  ''discount";  or  the  terms  of  his  agree- 
ment may  be  so  much  for  cash  within  30  days  or  longer, 
as  the  case  may  be,  which  means  that  the  goods  are  car- 
ried on  open  account,  and  if  they  are  settled  for  within  a 
specified  time,  a  given  discount  is  deducted.  In  this 
case,  there  is  no  commercial  paper  vrhatever.  There  may 
be  a  variation  of  this  type  of  transaction  whereby  C  asks 
B  for  a  ''note"  as  soon  as  B  gets  the  goods — that  is,  B 
takes  the  goods  away  and  gives  a  note  for  30,  60,  or  90 
days.  In  the  former  case,  C  may  get  accommodation  at 
his  bank  by  making  a  statement  which  shows  that  B 
owes  a  certain  amount,  and  so  gets  his  bank  to  finance 
him,  or,  if  B  has  given  the  note,  may  indorse  it  and  get 
his  accommodation  in  that  way.  In  either  case,  it  is  not 
likely  that  the  bank  could  dispose  of  B's  or  C's  note  to 
very  good  advantage.  In  Europe  the  transaction  would 
have  been  consummated  by  C's  drawing  upon  B,  where- 
upon B  would  accept  the  draft.  Then  this  draft  could 
be  discounted  at  a  bank  or  sold  to  someone  who  wanted 
an  investment  of  funds  for  the  life  of  the  draft.  Or, 
again,  C  might  have  agreed  with  B  that  the  latter  would 
pay  him  in  a  draft  accepted  by  a  banker.  Then  B  would 
induce  his  own  banker  to  accept  C's  draft  when  it  was 
drawn.  This  would  be  a  bankers'  acceptance — a  kind 
of  paper  very  popular  in  foreign  countries. 

The  spirit  of  the  Federal  Reserve  Act  is  strong  in 
favor  of  the  development  of  this  kind  of  paper  and  of 
the  older  double-name  U^e  of  paper,  whether  indorsed 
or  unindorsed.  Much  of  the  success  of  the  Act  will  de- 
pend upon  the  extent  to  which  the  desired  change  in  the 


Problems  of  American  Banking  341 

metliod  of  making  commercial  paper  is  applied  and  de- 
veloped. At  present  there  is  undoubtedly  great  hesita- 
tion on  the  part  of  American  business  men  about  aban- 
doning the  open  account  and  single-name  method  of  set- 
tling; but  it  may  be  supposed  that  if  lower  rates  can  be 
made  to  them  on  the  new  basis,  they  will  adjust  them- 
selves to  that  basis  more  or  less  speedily. 

Foreign  and  Domestic  Acceptances 

The  points  at  which  the  deficiencies  of  our  present 
method  of  settling  is  most  obvious  are  seen  in  the  devel- 
opment of  our  foreign  trade.  In  other  countries  almost 
all  foreign  trade  is  financed  on  a  basis  of  bankers'  ac- 
ceptances, drawn  in  the  way  heretofore  explained.  For 
instance,  suppose  that  A  in  Liverpool  hujs  wheat  from 
B  in  Minneapolis.  A  agrees  with  B  that  he  will  pay  for 
the  wheat  by  getting  the  Bank  of  Liverpool  to  accept 
B's  draft  at  sight.  This  means  that  B  at  the  time  that 
he  ships  his  cargo  of  wheat  draws  a  draft  on  the  Bank 
of  Liverpool  (arrangements  with  which  institution  have 
already  been  made  by  A),  and  this  draft  accompanied  by 
the  shipping  documents  can  then  be  discounted  at  a 
bank  in  Minneapolis.  The  Minneapolis  bank  knows  that 
the  draft  is  equal  to  a  promise  on  the  part  of  th«  Bank 
of  Liverpool  to  pay  and  that  if  this  is  not  made  good  at 
sight,  it  can  withhold  the  delivery  of  the  ^vlieat  through 
its  correspondent  in  Liverpool,  so  that  it  is  protected  to 
the  extent  that  the  wheat  has  value.  Under  the  old  sys- 
tem of  financing  foreign  trade,  an  American  buyer  who 
bought,  say,  woolen  goods  in  England,  had  to  arrange 
to  borrow  directly  at  his  bank,  say  in  New  York,  in  order 
to  get  funds  to  remit.  This  process  was  much  more 
clumsy,  the  paper  was  limited  in  its  market,  and,  due  to 
the  fact  that  A's  signature  was  not  widely  known,  his 


342  American  Banking 

note  could  not  be  generally  sold.  He  consequently  had 
to  pay  a  higher  rate  of  interest  for  his  accommodation. 

There  were  many  other  objectionable  effects  produced 
by  this  situation,  but  the  one  just  mentioned  was  of  itself 
enough  to  condemn  the  system.  It  was  for  this  reason 
that  the  Federal  Reserve  Act  made  provision  for  per- 
mitting national  banks  to  accept  bills  growing  out  of 
importations  and  exportations  to  an  amount  equal  to 
their  capital  and  surplus.  There  was  strong  pressure 
upon  Congress  to  extend  this  provision  to  domestic  bills 
of  exchange,  but  such  action  was  never  taken.  However, 
a  number  of  states,  conspicuously  New  York,  have  since 
then  provided  for  the  accepting  of  domestic  bills  of  ex- 
change by  state  banks,  and  the  Federal  Reserve  Board 
has  permitted  federal  reserve  banks  to  purchase  from 
state  banks  and  others  such  accepted  drafts  growing 
out  of  domestic  transactions,  through  the  exercise  of  the 
open-market  powers  of  the  federal  reserve  banks. 

Later  the  Act  was  amended  to  include  domestic  accept- 
ances, provided  such  shipments  are  accompanied  by  title 
documents  or  warehouse  receipts  maturing  in  not  more 
than  three  months '  sight.  Numerous  educational  efforts 
have  been  made  on  the  part  of  bankers,  business  men, 
and  commercial  organizations  to  encourage  the  use  of 
acceptances  in  the  regular  development  of  trade.  Some 
progress  is  slowly  being  made.  When  the  system  is 
finally  fully  understood  and  largely  used,  its  effect  should 
be  to  stabilize  credit  conditions. 

Question   of  Branches 

Closely  connected  with  this  whole  subject  is  the  ques- 
tion of  branches.  The  Federal  Reserve  Act  provides 
for  the  operation  of  branch  banks  abroad  by  member 
banks  possessing  capitals  of  $1,000,000  or  more,  pro- 


i 


Problems  of  American  Banking  343 

vided  that  such  banks  apply  to  the  Federal  Reserve 
Board  for  permission  to  establish  such  branches.  This 
provision  of  the  law  was  adopted  on  the  supposition  that 
f  a  considerable  number  of  banks  would  probably  take 
advantage  of  the  provision  of  the  Act  to  establish  them- 
selves in  foreign  countries.  Thus  far  only  a  few  have 
done  so,  and  other  banks  have  explained  their  failure  to 
take  any  action  by  pointing  to  the  hazards  of  branch  bank- 
ing in  foreign  countries  at  the  present  time,  in  view  of  the 
instability  of  "exchange  and  of  currency  systems  abroad; 
by  asserting  that  much  better  results  would  be  obtained 
if  they  were  permitted  to  join  together  for  the  purpose 
of  establishing  corporations  which  would  create  such 
branch  offices  abroad,  thereby  limiting  their  liability  to 
the  amount  that  they  had  invested  in  such  corporations ; 
and  by  suggesting  that  the  field  of  action  had  not  been 
well  divided  between  member  and  federal  reserve  banks 
in  foreign  operations. 

There  is  something,  no  doubt,  to  be  said  in  all  these 
respects.  Not  a  few  banks  have  been  of  the  opinion  that 
federal  reserve  banks  would  do  well  to  break  the  way  by 
proceeding  with  the  establishment  of  these  branches 
abroad,  thereby  perhaps  rendering  it  easier  for  mem- 
ber banks  to  ascertain  whether  there  was  a  real  field 
for  them.  On  the  other  hand,  the  banks  have  feared 
that  this  would  be  dangerous  competition  and  have 
thought  it  not  desirable  to  have  such  a  step  taken  by  fed- 
eral reserve  banks,  believing  the  first  step  to  be  arranged 
should  be  tlie  modification  of  the  Federal  Reserve  Act 
in  such  a  way  as  to  permit  united  action  by  banks  of 
the  kind  just  referred  to.  There  has  been  a  great  deal 
of  effort  to  make  a  start  at  some  point,  and  the  subject 
was  quite  fully  discussed  during  the  Pan  American 
Financial  Conference  held  in  Washington  in  May,  1915. 


344  American  Banking 

In  reporting  to  the  President  on  the  situation  as  created, 
Secretary  of  the  Treasury  McAdoo,  under  date  of  Sep- 
tember 6,  1915,  said : 

The  Federal  Reserve  Act  has  so  consolidated  and  organized 
our  credit  resources  that  our  bankers  are,  for  the  first  time  in 
our  history,  able  to  engage  in  world-wide  financial  operations. 
"We  now  have  the  available  resources.  It  is  merely  a  question 
of  their  intelligent  use. 

The  first  step  should  be  the  establishment  of  the  necessary 
branches  or  agencies  in  the  leading  cities  of  all  the  countries  of 
South  and  Central  America  by  a  bank  or  banks  having  the  neces- 
sary resources  to  take  the  business  that  is  open  to  them.  One 
of  our  largest  banks  has  had  the  enterprise  to  establish  branches 
in  some  of  the  largest  cities  in  South  America,  but  manifestly 
the  resources  of  a  single  bank  or  of  several  of  our  largest  banks 
are  insufficient  to  meet  the  demands  of  the  situation  as  it  now 
exists  and  as  it  will  develop  in  the  future.  What  is  needed  is 
the  use  of  the  consolidated  banking  power  of  the  United  States 
applied  through  agencies  established  in  the  leading  cities  of 
Latin  America. 

The  Federal  Eeserve  Act  has  supplied  the  necessary  author- 
ity, and  it  only  remains  for  the  federal  reserve  banks,  with  the 
approval  of  the  Federal  Reserve  Board,  to  make  practical  use 
of  that  poAver,  Section  14  (paragraph  e)  of  said  Act  gives 
every  federal  reserve  bank  the  right: 

"To  establish  accounts  with  other  federal  reserve  banks  for 
exchange  purposes  and,  with  the  consent  of  the  Federal  Reserve 
Board,  to  open  and  maintain  banking  accounts  in  foreign  coun- 
tries, appoint  correspondents,  and  establish  agencies  in  such 
countries  wheresoever  it  may  deem  best  for  the  purpose  of  pur- 
chasing, selling,  and  collecting  bills  of  exchange,  and  to  buy 
and  sell  with  or  without  its  indorsement,  through  such  corre- 
spondents or  agencies,  bills  of  exchange  arising  out  of  actual 
commercial  transactions  which  have  not  more  than  ninety  days 
to  run  and  which  bear  the  signature  of  two  or  more  responsible 
parties." 


Problems  of  Americnn  Banking  345 

In  addition  to  these  powers,  the  federal  reserve  banks  may, 
"under  rules  and  regulations  prescribed  by  the  Federal  Reserve 
Board,  purchase  and  sell  in  the  open  market,  at  home  or  abroad, 
either  from  or  to  domestic  or  foreign  banks,  firms,  corporations, 
or  individuals,  cable  transfers  and  bankers'  acceptances  and  bills 
of  exchange  of  the  kinds  and  maturities  by  this  Act  made  eligible 
for  rediscount  with  or  without  the  indorsement  of  a  member 
bank,"  and  may  "deal  in  gold  coin  and  bullion  at  home  or 
abroad,  make  loans  thereon,"  etc.,  and  "buy  and  sell,  at  home 
or  abroad,  bonds  and  notes  of  the  United  States,"  etc.  Enlarge- 
ment of  these  powers  would  be  desirable  to  increase  the  useful- 
ness of  foreign  agencies  of  federal  reserve  banks,  and  it  is  prob- 
able that  the  Congress  would  grant  such  enlarged  powers  upon 
good  cause  shown. 

The  twelve  federal  reserve  banks  could,  with  the  consent  of 
the  Federal  Reserve  Board,  establish  joint  agencies  in  each  of  the 
countries  of  Latin  America,  their  interest  in  such  agencies  to  be 
in  proportion  to  the  capital  stock  and  surplus  of  each  partici- 
pating federal  reserve  bank.  The  combined  capital  stock  and 
resources  of  our  federal  reserve  banks,  utilized  in  this  way  for 
the  extension  and  promotion  of  our  foreign  commerce,  would 
give  them  unrivaled  financial  power.  They  could  maintain 
themselves  in  foreign  fields  in  competition  with  the  world  and 
perform  a  service  of  incalculable  value  to  the  American  people. 

Subsequently  tlie  whole  subject  was  discussed  by  the 
Federal  Reserve  Board,  and  a  committee  report  was 
submitted  to  the  Board  for  the  purpose  of  outlining 
more  in  detail  the  precise  field  which  should  be  occupied 
by  the  federal  reserve  banks  and  their  relations  to  the 
operations  of  member  banks. 

The  committee  report  expressed  the  view  that  federal 
reserve  banks — being  custodians  of  the  reserve  money 
of  the  member  banks — should  not  be  permitted  to  do 
pioneer  work,  granting  credit  facilities  which  would  lead 
to  a  lockup  of  reserve  money  in  loans  which,  in  most  of 


346  American  Banking 

the  cases,  would  be  subject  to  mde  fluctuations  of  for- 
eign exchange.  Recommendations  for  joint  agencies  of 
federal  reserve  banks  did  not  contemplate  this  character 
of  operation. 

The  large  government  banks  of  Europe  do  not  go  into 
foreign  fields  except  that  they  hold,  as  secondary  re- 
serves, foreign  bills  on  the  most  important  European 
countries  where  large  discount  markets  exist  and  where 
the  gold  standard  is  established  beyond  question.  In 
those  countries,  these  government  banks  maintain  cor- 
respondents, and  it  was  believed  that,  when  normal  con- 
ditions should  be  restored  in  Europe,  joint  agencies 
or  correspondents  could  be  used  to  good  advantage 
there.  The  committee  also  called  attention  to  the  fact 
that  England,  Germany,  and  France  have  established 
independent  banks  or  branch  banks  of  deposit  banks  in 
Latin  American  countries  to  do  pioneer  work  and  that 
the  United  States  should  pursue  the  same  course,  inas- 
much as  it  is  necessary  for  banks  going  into  this  field 
to  have  the  widest  possible  range  of  activity  in  order 
to  be  able  to  compete  with  the  local  banks  and  the 
branches  of  the  foreign  banks  already  established  in 
these  fields.  Federal  reserve  banks  being  properly  re- 
stricted to  certain  transactions  and  such  as  may  not 
interfere  with  the  absolute  liquidity  of  their  condition, 
could  not  compete  successfully  in  this  respect,  whereas 
it  should  be  their  function  to  do  all  in  their  power  to 
assist  American  banks  which  enter  the  Latin  American 
field. 

The  committee  favored  an  amendment  of  the  Federal 
Reserve  Act  which  would  enable  American  member 
banks  to  co-operate  for  the  purpose  of  jointly  owning 
and  operating  foreign  banks.  The  contribution  of  the 
federal   reserve   banks    in   this    development   in   Latin 


Problems  of  American  Banking  347 

America  would  primarily  consist  in  providing  condi- 
tions so  favorable  for  American  acceptances  that  the 
American  banks  willing  to  offer  credit  facilities  there 
would  be  materially  assisted  in  meeting  the  European 
rates  which,  at  the  present  time  and  probably  for  some 
time  to  come,  will  compare  unfavorably  with  the  Ameri- 
can discount  rate. 

It  was  of  course  recognized  that  wherever  the  federal 
reserve  banks  can  help  in  the  development  of  American 
banking  by  establishing  direct  connections  in  Latin 
American  countries  for  the  purpose  of  facilitating  dis- 
count operations  of  this  kind,  it  will  be  their  proper 
function  to  do  so. 

The  committee  took  the  position  that  American  banks 
entering  this  field  ought  to  be  pennitted  to  develop  the 
opportunities  first,  but  that,  in  trade  centers  where 
American  banks  are  not  established,  it  might  be  proper 
for  the  federal  reserve  banks  to  appoint  joint  corre- 
spondents or  agents  in  order  to  facilitate  the  develop- 
ment of  American  acceptances  in  such  places,  although 
the  resources  of  the  federal  reserve  banks  should  not  be 
invested  in  non-liquid  loans  in  Latin  American  countries 
or  elsewhere. 

Up  to  date  no  branches  of  federal  reserve  banks  have 
been  established  in  any  foreign  country.  At  present, 
therefore,  the  situation  is  that  member  banks  may  estab- 
lish foreign  branches  subject  to  the  provisions  of  the 
Federal  Reserve  Act  and  that  a  few  have  done  so,  while 
the  Board  has  officially  announced  itself  as  favoring  the 
legal  recognition  of  co-operative  unions  of  the  banks  for 
the  purpose  of  establishing  foreign  agencies.  It  is  to 
be  assumed  that  federal  reserve  banks  will  establish 
branches  abroad  as  soon  as  conditions  in  foreign  mar- 


348  American  Banking 

kets  have  become  rather  more  stable,  so  as  to  permit 
such  action  with  a  fair  degree  of  safety  and  security. 

Use  of  American  Banking  Resources 

Since  the  beginning  of  the  European  war  the  general 
banking  question  has  greatly  broadened  and  amplified 
itself,  and  perhaps  the  greatest  problem  to  be  considered 
now  by  the  banking  system  of  the  United  States  and 
those  intrusted  with  its  leadership,  is  the  use  to  be  made 
of  its  resources  in  meeting  the  unusual  and  extensive 
demands  that  are  being  brought  to  bear  upon  it.  and  will 
be  increasingly  brought  to  bear  in  the  future  in  view  of 
the  destruction  of  capital  in  Europe.  Of  course,  it  is  a 
primary  necessity  to  protect  and  safeguard  the  domestic 
banking  situation  and  to  see  that  every  legitimate  need 
for  short-term  capital  is  supplied.  But  it  remains  true 
that  an  unprecedented  burden  has  been  laid  upon  the 
financial  institutions  of  the  United  States  in  connection 
with  the  financing  of  American  foreign  trade.  This 
duty  includes  both  the  immediate  matter  of  providing 
financial  support  for  the  present  export  trade  and  of 
furnishing  later  on  the  necessary  facilities  to  keep  and, 
if  possible,  extend  this  trade  after  the  war  is  over  and 
after  business  conditions  have  been  restored  to  some- 
thing like  normal. 

At  the  beginning  of  the  struggle  Europe  took  our 
goods  and  paid  us  by  cancelling  our  floating  indebted- 
ness on  open  account;  later  our  goods  were  taken  and 
were  paid  for  by  the  shipment  of  American  securities, 
which  were  converted  into  means  of  pajmient  through 
sales  in  the  United  States.  At  length  there  has  set  in 
a  period  in  which  Europe  still  desires  to  obtain  our 
goods,  but  would  do  so  upon  a  basis  of  credit  accounts 
with  the  United  States.    The  situation  is  one  that  pre- 


Problems  of  American  Bmiking  349 

sents  unusual  and  perplexing  problems  of  policy  and  at 
least  suggests  the  possibility  of  difficulties  in  commerce, 
trade,  and  industiy  that  may  cause  hardship  if  not 
courageously  and  skillfully  dealt  with. 

Financing  Exports 

The  United  States  is  in  a  position  which  requires  it 
in  its  own  interest  to  finance  its  exports  to  foreign  coun- 
tries. A¥e  cannot  indefinitely  say  to  these  foreign  coun- 
tries, ''Pay  us  in  gold,''  or  even,  "Pay  us  in  our  own 
securities."  To  some  extent  both  these  methods  of 
payment  undoubtedly  will  be  adopted,  but  there  are 
practical  limits  upon  each.  Even  if  seeking  to  get  gold 
we  should  not,  as  a  European  statesman  has  recently 
said, ' '  absorb  the  monetary  systems  of  Europe, ' '  or  even 
weaken  them  by  so  far  sapping  their  underlying  struc- 
ture of  gold  as  to  embarrass  future  financial  relations 
wdth  such  countries.  We  may  ask  that  our  securities 
shall  be  returned  to  us  so  far  as  possible,  or  at  least 
such  an  amount  of  the  securities  as  are  within  reason- 
able reach.  If  we  were  to  insist  upon  either  gold  or 
American  securities  as  a  means  of  pajniient  for  exports, 
it  may  be  questioned  how  far  our  exports  would  go. 

Curtailment  of  exports  might  not  be  a  matter  of 
national  concern  if  they  were  limited  solely  to  the  ex- 
traordinary orders  which  have  grown  out  of  the  present 
war,  but  this  is  not  the  case.  To  many  foreign  buyers 
the  war-order  purchases  seem  more  urgent  than  the 
ordinary  requirements  of  commerce,  and  given  a  choice 
between  the  two,  it  might  be  the  latter  that  would  suffer. 
Were  we  to  refuse  to  finance  our  own  foreign  trade  at 
its  present  volume,  might  not  the  reduction  of  the  trade 
be  seen  in  a  curtailment  of  shipments  of  cotton  and 
many  other  commodities  which  to  us  appear  as  staples, 


350  American  Banking 

but  which  to  foreigners  engaged  in  a  life  and  death 
struggle  are  things  that  can  for  a  time  perhaps  be  dis- 
pensed with,  or  whose  consumption  may  be  reduced? 
"VVe  cannot  discriminate  between  the  different  classes 
of  exports  which  draw  upon  the  banking  machinery  of 
the  countiy  for  the  means  wherewith  to  supply  a  finan- 
cial basis  for  their  movement.  Could  this  be  done,  and 
could  we  be  the  determining  factor  as  to  the  classes  of 
exports  which  we  would  preferably  finance,  the  situation 
would  be  different.  The  fact  is  that  our  sales  are  de- 
termined by  demands  abroad,  and  that  we  supply  what 
our  customers  call  for.  If  we  limit  their  consuming 
power  too  drastically,  the  question  will  remain  at  what 
point  and  upon  what  lines  of  goods  they  will  begin  to 
curtail  the  purchases  they  make;  and  this,  in  the  last 
analysis,  is  not  a  matter  over  which  we  have  control. 

Long-Teem   Credits  Necessary 

We  shall  ultimately  have  to  decide  in  our  own  minds 
about  how  far  we  are  willing  to  grant  accommodation 
to  foreign  buyers  of  our  goods  of  every  description. 
Usually,  of  course,  these  buyers  have  expected  to  pay 
us  by  short-term  claims  upon  goods  manufactured  in 
their  own  countries  and  shipped  to  the  United  States, 
but  these  goods  are  now  greatly  reduced  in  volume.  The 
productive  power  of  most  nations  has  been  devoted  to 
the  manufacture  of  munitions  of  war  or  to  the  actual 
maintenance  of  armies  in  the  field.  They  are  not  in  a 
position  to  produce  the  goods  which  we  have  asked  for 
in  the  past  and  which  today  we  would  stand  ready  to 
take  as  a  means  of  pajTnent  for  our  cotton,  grain,  meat, 
and  manufactures.  It  may  almost  be  said  that  in  this 
way  every  class  of  foreign  purchaser  is  practically  in 


Problems  of  American  Banking  351 

a  position  in  which  he  is  dependent  upon  the  getting 
of  a  long  period  o-f  credits. 

As  has  already  been  said,  how  long  such  credit  shall 
be,  and  what  shall  be  its  nature,  is  a  matter  which  Ameri- 
can business  men  and  bankers  must  thoughtfully  ponder. 
There  is  no  disguising  the  fact  that  what  Europe  is 
now  asking  for  is  a  general  power  to  draw  upon  our 
resources  of  consumable  goods,  which  means  a  request 
for  power  to  employ  our  productive  machinery  simply 
upon  the  promise  ultimately  to  pay  us  back  when  circum- 
stances will  permit.  Were  we  to  insist  on  payment  either 
in  gold  or  in  securities,  we  should,  to  a  very  great  degree, 
limit  our  own  earning  power  and  to  that  extent  throw 
out  of  gear  our  means  of  production.  We  have  in  the 
past  depended  upon  Europe  to  take  from  us  each  year 
several  million  bales  of  cotton  and  many  millions  of 
bushels  of  grain.  We  cannot  now  interrupt  this  exist- 
ing process  without  seriously  checking  the  production  of 
the  United  States.  And  yet,  of  course,  we  must  set  a 
limit  to  our  sales  abroad,  based  on  what  we  believe  to 
be  the  power  of  our  customers  in  other  countries  to  pay 
for  the  goods  that  are  supplied  them. 

Obligations  upon  the  Banks 

The  banking  phase  of  this  question  is  even  more  im- 
portant perhaps  than  the  commercial.  It  is  evident  that 
we  cannot  carry  more  than  a  certain  amount  of  foreign 
credit  as  an  element  in  the  liquid  assets  of  our  banks. 
Were  they  to  become  too  largely  involved  in  this  way, 
it  would  be  easy  for  them  to  pass  from  the  present 
condition  of  abundant  liquid  resources  to  the  opposite 
situation.  Let  it  be  borne  in  mind  that  the  United  States 
has  been  a  borrowing  and  not  a  lending  country.  If  it 
now  assumes  the  functions  of  financing  great  quantities 


352  American  Banhing 

of  foreign  obligations,  it  must  do  so  with  the  knowledge 
that  such  operations  imply  the  withdrawal  of  a  more 
than  proportionate  amount  of  capital  from  the  perma- 
nent uses  that  have  heretofore  called  for  them.  Our 
banks  have  a  duty  to  perform  in  keeping  their  funds 
liquid  and  in  avoiding  any  course  that  could  be  held  to 
limit  their  power  of  meeting  unexpected  financial  neces- 
sity on  the  part  of  the  borrowing  public  of  this  country. 
The  obligation  thus  resting  upon  the  banks  is  the 
greater  because  of  the  fact  that  for  some  time  to  come 
they  must  undoubtedly  provide  for  an  immense  quan- 
tity of  domestic  products,  cotton,  grain,  and  the  like, 
which  in  years  past  has  been  financed  abroad,  but  which 
now  must  be  carried  by  American  capitalists  because 
of  the  fact  that  foreign  countries  are  turning  so  gen- 
erally to  this  nation  for  aid  in  the  transaction  of  their 
ordinary  business.  Certainly  this  necessity  of  financ- 
ing will  be  met  with  in  the  case  of  all  those  products  of 
which  a  large  supply  must  be  carried  over  a  long  period 
or  season,  awaiting  the  development  of  actual  demands 
abroad.  They  must  remember  that  unusual  necessities 
in  the  interior  of  the  country,  as  well  as  unusual  demands 
from  elsewhere,  are  confronting  them  and  that  their 
ability  to  supply  all  legitimate  requirements  of  regular 
trade  will  be  in  no  small  degree  measured  by  the  extent 
to  which  they  husband  their  resources  in  connection  with 
abnormal  or  unusual  demands. 

Responsibilities  upon  Business  Men 

Our  business  men  and  manufacturers  have  themselves 
a  very  heavy  responsibility  at  the  present  time.  Past 
experience  shows  that  financial  prosperity,  due  to  dis- 
turbed or  unusual  conditions,  not  only  does  not  last,  but 
is  usually  followed  by  reaction  and  loss.     There  were 


Problems  of  American  Banking  353 

many  persons  just  before  the  close  of  the  Civil  War 
who  imagined  themselves  possessed  of  enormous  wealth, 
but  who,  in  fact,  found  that  the  collapse  of  values  follow- 
ing the  war,  left  them  with  hardly  any  of  the  property 
they  had  imagined  themselves  to  have.  It  would  be 
easy  for  the  United  States  to  expend  its  wealth  in  plant 
and  manufacturing  equipment  for  the  purpose  of  taking 
advantage  of  what  seem  like  profitable  orders  from  for- 
eign countries,  only  to  find  when  peace  returns  that  much 
capital  had  been  invested  without  any  reasonable  pros- 
pect of  continuous  employment  for  the  future. 

No  doubt  there  are  some  concerns  who  are  so  fully 
protected  by  the  terms  of  their  contracts  that  they  can 
afford  to  invest  in  this  way,  even  if  the  extension  of 
plant  and  equipment  which  they  may  make  should  be 
practically  unavailable  after  the  war  is  over.  Their 
profits  may  be  so  large  as  to  safeguard  them  individu- 
ally against  the  possibility  of  loss.  The  fact  will  re- 
main, however,  that  the  capital  of  the  community  has 
been  devoted  to  a  use  which  has  proved  only  temporary 
and  that  the  plant  and  equipment  provided  by  the  use 
of  such  capital  are  not  available  for  continuous  working 
because  of  lack  of  demand  for  the  products  which  it 
turns  out.  In  such  a  case  the  resources  of  the  country 
would  have  been,  so  far  as  immediate  advantage  goes, 
destroyed;  and  in  place  of  them,  the  nation  as  a  whole, 
would  have  received  simply  a  claim  upon  the  future  in- 
dustry of  other  nations  which,  at  best,  would  be  a  long 
time  in  being  realized.  It  is  easy  to  see  that  we  have 
here  the  elements  of  a  process  of  inflation  and  specula- 
tion which  might  be  carried  to  great  length  should  the  ab- 
normal conditions  of  business  in  the  United  States  con- 
tinue and  should  the  trade  with  Europe  be  placed  upon 
a  footing  of  unsound  or  exaggerated  credit. 


354  American  Banking 

DoLLAE  Exchange 

Tlie  United  States  can  do  much  to  finance  itself,  meet 
European  demands  for  goods,  and,  at  tlie  same  time, 
occupy  a  safe  position  by  undertaking  tlie  normal  financ- 
ing of  ordinary  trade  with  neutral  nations,  "which  has 
heretofore  been  conducted  by  foreign  financiers.  This 
could  be  done  by  the  more  general  adoption  of  dollar 
exchange  in  international  trade.  If  London,  for  ex- 
ample, is  willing  to  turn  over  to  New  York  the  function 
of  accepting  against  South  American,  Eastern,  and  other 
purchases,  the  merchants  and  banks  of  this  country  may 
relieve  European  financial  institutions  of  a  considerable 
part  of  the  burden  resting  upon  their  resources  by  pro- 
viding for  the  requirements  of  their  ordinary  trade. 
Were  the  banks  of  the  United  States  to  assume  this 
function,  they  would  relieve  the  banks  of  Great  Britain 
of  a  drain  upon  their  resources,  which  would  enable  them 
to  accommodate  the  requirements  of  the  temporary  ab- 
normal trade  of  their  own  country. 

The  United  States  would,  however,  have  gained  the 
advantage  of  developing  a  normal  accepting  relationship 
with  many  parts  of  the  world,  where  this  branch  of  busi- 
ness must,  under  ordinary  conditions,  be  slowly  built 
up  by  us,  if  at  all.  American  bankers  must  enlarge  their 
support  of  neutfal  and  normal  trade  to  the  utmost  limit, 
assiduously  working  to  maintain  the  assets  of  their  in- 
stitutions in  as  liquid  a  condition  as  possible  and  refrain- 
ing from  the  purchase  of  an  undue  amount  of  any  class 
of  paper  which  requires  an  extra  long  term  for  liquida- 
tion. 

In  all  this  the  federal  reserve  system  has  no  doubt  an 
important  part  to  play.  It  must,  above  all  things,  con- 
serve  its   resources   for   the   liquid   commercial   trans- 


Problems  of  American  BanJcing  355 

actions  whose  financing  it  was  originally  designed  to 
carry.  It  must  be  prepared  to  supply  accommodation 
at  every  point  where  possible  friction  or  difficulty  may 
occur,  and  to  this  end  it  must  co-operate  actively  with 
member  banks  in  rediscounting  paper  of  suitable  kinds 
Avherever  such  action  is  necessary  in  order  to  meet  a 
general  public  demand.  It  must,  above  all  things,  en- 
deavor to  encourage  the  member  banks  in  the  policy  of 
conservative  development  and  of  caution  with  respect  to 
unfamiliar  operations,  as  has  been  outlined.  It  must 
safeguard  with  peculiar  care  the  interests  of  the  pro- 
ductive communities  of  the  United  States. 

The  federal  reserve  banks  are  frequently  spoken  of, 
and  no  doubt  correctly,  as  bankers'  banks,  but  they  are 
bankers '  banks  on  the  public  and  not  on  the  private  side. 
They  are  bankers'  banks  so  far  as  the  bankers  perform 
a  public  service;  they  are  not  bankers'  banks  so  far  as, 
bankers  are  in  search  primarily  of  their  own  profit.  They 
are  bankers '  banks  in  the  sense  that  they  work  through 
bankers  for  the  purpose  of  equalizing  supplies  of  capital 
and  rates  of  interest  and  of  conveying  to  the  public — 
manufacturers,  merchants,  and  farmers — all  those  bene- 
fits that  result  from  united  and  uniform  financial  action. 


TEST  QUESTIONS 

1.  What  may  be  said  to  be  the  central  idea  of  the  federal 
reserve  system? 

2.  Why  were  powers  to  engage  in  open-market  operations 
given  to  the  federal  reserve  banks?  Explain  how  these  powers 
rest  on  experience. 

3.  Explain  the  two  theories  commonly  held  as  to  the  proper 
functions  and  activities  of  the  reserve  banks.  What  is  the  evi- 
dent intention  of  the  statute  ? 


356  American  Banking 

4.  Under  what  conditions  may  state  banks  enter  the  reserve 
system  ? 

5.  What  are  the  advantages  to  state  banks  of  membership  in 
the  system?     The  disadvantages? 

6.  From  the  standpoint  of  our  national  banking  system,  is 
it  desirable  that  state  banks  should  become  members?    Why? 

7.  Explain  the  provisions  that  have  been  made  for  the 
reserve  banks  to  act  as  fiscal  agents  of  the  government. 

8.  Show  how  the  Federal  Reserve  Board,  through  the  process 
of  rediscounting,  can,  for  practical  purposes,  throw  the  resources 
of  two  or  more  reserve  banks  together. 

9.  What  are  some  of  the  classes  of  commercial  paper  admitted 
under  the  Act  for  advancement  of  funds?  What  are  some  of 
the  immediate  problems  in  this  field  ? 

10.  How  do  commercial  transactions  on  open  account  differ 
from  transactions  evidenced  by  bankers'  acceptances? 

11.  Explain  the  process  of  settling  foreign  accounts  by  means 
of  foreign  acceptances.     Illustrate. 

12.  What  provisions  does  the  Federal  Reserve  Act  make  for 
enabling  our  banks  to  aid  in  the  financing  of  foreign  trade? 

13.  What  two  provisions  does  the  Act  make  for  branch  bank- 
ing abroad?  What  are  some  of  the  immediate  problems  to  be 
faced  in  this  field  ? 

14.  What  were  the  recommendations  of  the  committee  report 
submitted  to  the  Federal  Reserve  Board  on  branch  banking  in 
foreign  countries? 

15.  What  are  some  of  the  banking  problems  created  by  the 
large  war  exports? 

16.  What  are  the  developments  with  regard  to  dollar  ex- 
change ? 

17.  In  what  sense  are  federal  reserve  banks  bankers'  banks? 


INDEX 


Acceptances,  bankers',   31-32        .,  ..   , 
development    In    use    of.    in    Unitea 
States.  83 

nmlt'atioii  ?n^dIscount  of.  under  Fed- 
eral Reserve  Act,  39        ^ 
Acceptances,   foreign    trade,    (fa- (7 

iren'^cll''?orSf'of    federal    resecve 
banks.  82,  292-94 

^'?ompaS'wS  Federal  Reserve  Act. 

proviVfons    of.    as    to    foreign    trade 
financing.   75 
^^SteSrS'ln^^'nance  of  European 
war,  130 
^^o'Snf  of.'^as  to  emergency   cur- 

Amerfc°*if'Bankers'  Association,  131 
Association  ,_  ,o 

building  loan,  17-18 

rrowt"h'of!'ia   banking,    107-8,    131 
Balance  of  trade,  74 
'and  the  government,  185-204 
and  the  Treasury,  221-22 
as  a  going  concern.  147-48 
bookkeeping,   144-40 
capital,    133-30.    147-48.   17» 
(See  aUo  Capital) 

^Ifmmerctl,^  wirk   of,   different   from 
that  of  federal  reserve  banks,  190- 

93 
correspondent,  62 
credit  department,  35-^fa 
credit  function  of,  A,  o-/ 

^^^^^e''a?«o"feposit.bank) 
dividends,  149,  150-52 
English    joint-stock     304-5 
examinations,  1^3-95.  2brf 
examiners,  194,  197-98,  263 
Irtt    of  the  united  States    206-8 
hard-pressed,    relief    of-    "7    ^' 

eral  Reserve  Act,  I60-6T 
inspection,  purpose  of,  184 

national,   12-13  ini  d 

Sotes.  federal  reserve  101-4 
of  England.  301-4  306.  3-U 
of    B^rance.    20.    dUo  ia  qh  ic; 

of  Germany  (Keichsbank).  311-15 
officers,   135-44  ko^l-^ 

(Sec  aim  Officers,  bank) 
organization    sheets,    138    (l^ig-    ^' 

139   (Fig.  3)      _„  .„ 
organization  of,   \6i-vi 

orlgla  of.  3 


other  foreign,   319 
private,    14-15 

rlL'rve',    6^62^   152-63,    189-90 

(See  (lUo  Reserve) 

llcS'ofthI  united  States.  209-11 
state,  13-14.  217-18 
statement,    l<7-84  ,„„^^ 

(See  also  Statement,  bank) 
surplus,  creating  a,  148-50 
surplus  funds,  use  of    3b-i8 
undivided  profits,   lo0-52 

Banking  „„     „op     300-1. 

American,    21.    20o-22,    ^»fa.    """  a, 

Kl'.'1i7%.  ^S?-!!  -y  S''  s. 

^^(See  also  Branch  banking) 
Canadian.  20-21.   315-19 
rpntral    svstems  of.  -iU 
centrtlized.  lessons  of  experience  in, 

chiJacterlsUcs    of    modern    systems 
de?elopmeS     of     national     systems, 

226-28  ,  .    „  o 

economic  services  of.  -^■•i 
English   joint-stock    304-5 
foreign,  275- <  6    319 
functions  of,  1-T,  4a         ois  10 
growth  in  soundness  of,  -18  19 

SdSdent'chafter,  systems  of    20 
iSdIpeSdeSt  competitive,  systems  of, 

individual  services  of,  2 
legal  status  of.  lO-l^ 

21 
Scotch,   3O0-8  Q     008-9     212-18 

state    banks,    197-9»,    -"o  >'' 

(lee  aJso  State  banks) 
under'National  Bank  Act.  224-38 

«-h^ir"fct1^-?^ti^f  of  modern    321 

rnStfon*^runder%-e\al  Reserve 

Act.  296-99 
Bills  of  exchange 
documented.  29 
loans  secured  by,  -8-rfi 
in  foreign  trade,  29-30 

''^brigS^fe^rl^^e^"- 
puSle 'of,"' under    National    Bank 
rep'^eal   of 'b'nd  deposit  requirement 
urged,  232 

357 


358 


Index 


rise  In  price  of,  228-30 
transfer  of,  to  federal  reserve  banks, 
277-79 
Borrower,   testing  tlie,   34-35 
Branch   banking,   75,   319 
Canadian,  318-19 

In  foreign  trade,   under  Federal  Re- 
serve Act,  292-94,  343 
under    Federal    Keserve    Act,    75-76. 
283-84 
Broker,  note,  46-47 

Canadian  banking 

as  exemplifying  one  type  of  bajiking 

system,  320 
brancli  banking  In.  318-19 
security  of  uote_isau£aJi»T-83 

amount  of,  147-48 
and  reserves,  147-76 
item  In  bank  statement,  178 
payment  of.  133-35 
Certificates,    clearing-house,    123-25 
an  extreme  remedy,  124-25 
In  finance  of  European  war,   129-30 
Cliecks 

out-of-town,   clearing  of,   114-16 
(Hce  also  Collection  of  cliccks) 
Classes   of  banks 

according   to   commercial    status,    11 
according  to   legal   status,    10 
Clearing  house 
cash,   111-12 
certificates.  123-25,  129-30 

(<S'ee     also     Certiiicates,     clearing- 
house) 
clearings,  significance  of,  112-14 
gold   settlement   fund   under   Federal 

reserve  system,   118-20,   205 
national    system    of,    under    Federal 

Keserve  Act,  116-20.  264-65 
nature  of,  108-9 
New   York,   113 
process  of,  109-11 

service    of,    in    strengtheaiDg    confi- 
dence, 120-23 
table  of  clearings,  113 
wide   use  of,    108 
Collection   of  checks,   67-70 

at  par,   under   Federal   Keserve  Act, 

252 
charges   for,    reduced   under   Federal 

Keserve  Act,  289-90 
checks  treated  as  cash,  69-70 
under  Federal  Keserve  Act,  116-20 
Companies 

Insurance,   18-20 
loan  and  trust,  15-16 

{See  also  Trust  companies) 
Comptroller  of  the  Currency 
calls  of,   195 

co-operation   with   state  banking  de- 
partments, 198 
functions   of,    193-94,    196-97 
position     of,     on     Federal     Reserve 
Board,  262 
Cotton  exchange,  closing  of,  upon  an- 
nouncement of  European  war,  128 
Credit 

affected    by    federal    reserve    system. 

287-89 
function  of  the  bank,  3,  6-7 
studying,  35-36,  .43 


transactions,  4-5 

Crises,  action  of  banks  In,  323 

Currency 

associations.   238 

demands  for,  103-4 

legislation   of  1908,   236-38 

relation  of  deposits  to,   55-56,   86-87 

under  National  Bank  Act,  224-36 


Deficit,  financiering,  231-33 
Deposits 

bank,   51-62 

cancellation  of,  57-58 

classes   of,   52-54 

distrilHition   of,   56-57 

function  of,  7 

government,    200-3,    277-79,    337 
(See  also  Treasury,  Independent) 

guaranty   of,   174-76 

how  made,  51-52 

Inter-bank,   61-62 

nature  of,  54-55 

relation  to  currency,  55-56 

significance  of,  59-60 

table  of  deposits,  61 

volume  of.  -60-61 
Directors,  board  of.  In  federal  reserve 

system,  265-66 
Discount 

encouraged    under    Federal    Reserve 
Act,  288 

forms  of,  24-26 

function   of,   7 

rate  of,  how  determined,   163-64 

V.  purchase,  in  operations  of  federal 
reserve  banks,    171-73 
Dividends,  bank 

declaration  of,  149 

equalized   by   undivided  profits,    150- 
52 

item  in  bank  statement,  180 
Draft 

definition  of,  25 

use  of,   25-26 

European  war 

Ijanking,  effect  of  upon,  301 
Bank  of  England,  operations  as  af- 
fected by,  306-8 
Bank    of    France,    operations    as    af- 
fected by,  310-11 
Bank  of  Germany    (Reichsbank),  op- 
erations as  affected  by,  313-15 
Canadian    banks,    operations    as    af- 
fected by,  316-17 
finance  of,  in  Germany,  313-15 
finance  of,  in  Great  Britain,  306-8 
finance  of.  In  United  States,  127-31 
Examinations,  bank,  193-95 

under    Federal   Reserve  Act,    194-95, 
263 
Examiners 

as    organized    by     Federal     Reserve 

Board,  263 
reorganized   for  federal  reserve   dis- 
tricts, 194 
state   bank,   197-98 
work  of,  194 
Exchange 

cotton,    closing    of,    upon    announce- 
ment of  European  war,  128 


Index 


359 


domestic.  64-70 

(See    also    Checks,    collection    of; 
Clearing  house) 
foreign.   72-83,   30S.   310-11,   314 
stock,  closing  of,  upon  announcement 
of  European   war.    128 
Export  trade,  mode  of  financing,  349 

Federal  Reserve  Act 

acceptances,  bankers',  under,  31-32 
acceptances,  foreign  trade,  under,  77, 

79 
bank    notes,    federal    reserve,    under, 

101-4 
bonds,    purchase    of,    by    federal    re- 
serve banks,  under,  96 
branch  banks,  under,  75-76 
broad  principles  of,  285-87 
check  collection  at  par  provided  for 

under,  252 
check  collection,  charges  for,  reduced 

under,  289-90 
clearance  system  under,  116-20,  264- 

65 
comment  on,  1 
congressional  action  on  the  bill,  246- 

50 
criticism  of,  45 
criticism    of    reserve    provisions    of, 

159-60 
effect  of,   upon   reserves,   159-60 
foreign    trade,    financing    of,    under, 

75-82,  292-94 
history    of.    240-41 
independent         Treasury  system, 

changes  in,  made  possible  by,  277- 

79 
loans,  commercial  purpose  of,  under, 

42-44 
notes,  federal  reserve,  under,  98-101 
open-market   operations    under,    169- 

71 
original    bill,    essential    features    of, 

241-46 
paper  eligible  for  rediscount  under, 

167 
rediscount  under.  39-42,  165-67 
relation    of.    to   Aldrich    Bill,    251-52 
reserves,   156-60,  162-63,  252,  290-91 

(See  also  Reserve) 
reserve    provisions    of,    effect    upon 

profits  of  bank,  160-62 
sources  of  the  bill.  250-53 
trust-company    powers,    granting   of, 

under,  297 
Federal  reserve  banks 

agencies,   foreign,   82,  292-94 

as  fiscal  agents   of  the  government, 

201,    203.    277-79 
benefit  to  public  from  rediscount  and 

purchase  operations  of,   172-73 
branches    of   member   banks    abroad, 

292-94 
capital  of,   280 

clearing-house   function  of,   122-23 
control  of,   by   directors,   265-66 
directors,  appointment  of,  by,  265-66 
discount  v.  purchase,  171-73 
examinations  by  and  of,  194-95,  263 
foreign  operations   of,    82-83,    292-94 
function  of,  165-66,  169 
in  times  of  panic,  323-28 
loans,  oversight  of.  by,  190-93 


member    banks,    obligations    to,    by, 
170-71 

nature  of,  13,  327 

organization   of,  138    (with  chart) 

plan    of    government    control    illus- 
trated by,   199 

purpose  of,   280 

rate  of  interest,  168-71 

rediscounts,    protection   of,    by,    168- 
69 

regional  character  of,  280 

Illation  of,  to  state  banks,  329 

reports  of,  to  Federal  Reserve  Board, 
196,   264 

reserves,  holding  of,  by,  62 

supervision    of,    by    Federal    Reserve 
Board,  205 

work  of,  different  from  that  of  com- 
mercial institutions,   l£R)-93 
Federal   Reserve  Board 

administrative    duties   of,    256-58 

Advisory    Council,    267-68 

agents,  relation  of,  to,  206-67 

appointment  of  members  of,  255 

Bulletin  issued  by,  197,  260 

Bureau   of   Audit   and   Examination, 
263 

Comptroller  of  the  currency  a  mem- 
ber of,  262 

constructive  duties  of,  258-60 

directors,  board  of,  .265-66 

Division  of  Clearing,  264-65 

Division   of    Reports   and   Statistics, 
264 

educative  functions  of,  260-61 

functions  of,  256 

organization   of,    261-62 

view  of  reserve  banks,  328 

reports  of,  197,  260 

reports     to,     from     federal     reserve 
banks,  264 

Secretary  of  the  Treasury  a  member 
of,  262-63 

supervision  of  federal  reserve  banks 
by,  265 
Federal  reserve  system 

agents,  duties  of,  266-67 

branch  banking  in,   283-84 

branch  banking  in  foreign  trade  en- 
couraged by,  292-94 

broad  principles  of  the  plan,  285-87 

business  aided  by,  287-89 

compared     with     European     central 
banking  systems,  281-82 

control  of,  255-68 

credit,  affected  by,  287-89 

discount       market       provided       for 
through,  288 

field  covered  by,  45 

gold,  economy  in,  effected  by,  290-92 

gold  settlement  fund,   118-20,  265 

industry,  relation  to  of,  294-95 

inflation,  danger  of,  upon  release  of 
reserves  through,  290-91 

interest  rates  affected  by,  287-89 

membership  in,   296-99 

national  banks,   membership  in,  282, 
296-99 

panics   prevented   by.   288-89 

purpose  of,  165 

services  of,  45-46 

state  banks,  membership  in,  282-83, 
296-99 


360 


Index 


unification    of    banking    system    af- 
fected by,  296-99 
Finance,   war,   127-31 
Fowler  Bill,  236-37 

Glass,  Carter,  240-41 

report  submitted  by,  to  House,  241- 
46 
Gold 

economy   in,    effected  by   federal   re- 
serve system.   290-92 

reserves,  in  United  States,  291 
Government 

and  the  banlss.  185-204,  269-79 

control  of  interest  rates,  199-200 

control    of    national    banks,    187-90, 
193-97 

control    of    state    banking    systems, 
197-98 

control,  principles  of,  186-87 

deposits,   200-203.   277-79 

direct  control,   198-99 

finances    and    the    reserve    system, 
269-79 

inspection    and    examination    of    na- 
tional banks,  193-95 

regulation     of     loans     of     national 
hanks,   187-89 

requirements   as   to   reserves   of   na- 
tional banks.  189-90 

surplus,  deposit  of,  in  banks,  270-74 

surplus,  growth  of  a.  230-31 
Greenbacks,  issue  of,  221 
Guaranty  of  bank  deposits,   174-76 

Hamilton.  Alexander.  206 
History   of   banking  in  United   States, 
205-22 

Industry,  relation  to,  of  federal  reserve 

system,  294-95 
Inflation 

conditions  of,  59 

danger  of,  upon   release   of  reserves 
under  Federal  Reserve  Act,  290-91 
note,   91-92 
Insurance  companies,  18-20 
Interest,  rate  of 

as  affected  by  federal  reserve  system, 

287-89 
as   affected   by    rediscount   and    pur- 
chase operations  of  federal  reserve 
banks,  172-73 
charged    by    federal    reserve    banks, 

168-69 
control  of,   199-200 
elements  of,  168 

made    effective    by    federal    reserve 
banks.   109-71 
Issue,  function  of,  7 

Jackson,  Andrew,  210 

Liabilities 

guaranteeing,    174-76 

items   considered  as,    in   bank   state- 
ment,   178-84 
Loans 

actual  bank,  47-48 

bank,  22-24 

call,  27 

collateral.  26-28 

commercial  purpose  of,  42-44 


in  international  trade,  80-82 

on  documented  bills  of  exchange,  28- 

29 
oversight   of.    190-93 
prohibited,  187-88 
regulation  of,  187 
restriction   on,   188-89 
specializing  in,   48-50 
table  of,  48 

Money,   movements   of,    79-80 
Moratori\im.   130-31 

established   by   Bank   of   England   at 
outbreak    of   European    war,    306-8 

National   Bank  Act.   224-38 

bonds,   purchase  of.   under,   224-26 

capitaf.   133-35.   148 

development    of    the    system    under, 

226-28 
dividends,  declaration  of,  under,  149 
examiners  under.  193 
interbank  deposits  of  national  banks 

under.   61-62 
limitation  of  as  to  specialization  in 

loans,  40-50 
'.  kians.  regulation  of,  by,   187-89 
nature  of.  224-26 

notes,  protection  of.  under.  173.  189 
officers  of  a  bank,  under,  135-44 
organization  of  a  bank,   under,  133- 

34 
reserve,  deposit  of.  in  reserve  cities, 

under.  61-62.  152-50 
reserve,  maintaining  of,  under,   152- 

54.  189-90 
surplus,  under.  149 
Notes 

elasticitv  of,  104-6 

emergency,  125-27.  129-30 

federal   reserve.   98-101 

federal  reserve  bank,   101-4 

inflation  of.  91-92 

issue  of  under  currency  legislation  of 

1008.  236-38 
national  l)ank  notes.  224-31 
nature  of.  85-86 
need  for  uniform  Issue  of,  219 
protection  of.  87-89,   173-74 
redemption   of.  93-95 
relation  of,   to  currency,   86-87 
theory  of  issue  of.  92-93 
ultimate  securitv  of,  95-96 
why  issued,  89-91 

Officers,  bank,   135-44 

cashier,  139-40 

discount   clerk.   144 

note  teller.   142-43 

"other  officers."  137-38 

paying  teller.   140-41 

president.   135-36 

receiving  teller.   141-42 

vice    president,    136-37 
Open-market  operations  under  Federal 

Reserve  Act,   169-71 
Overdrafts,   183 

Panic 

demands  of  1914.  103 

of  1837,  218-19 

of  1907,  125,  235-36 


Index 


361 


Paper 

accommodation,   24 

buying  of,  36-38 

classes   of  commercial  and  non-com- 
mercial, 39-42 

eligible   for   rediscount   with   federal 
reserve  banks,   39-42,  45,   1G7 

future  of,   339 

single-name,   distribution  of,  46-47 

single-name  v.   double-name,   44-46 
Profit,   "double,"   228 

Rate 

of  discount,  how  determined,  163-64 

of  exchange,  67-69,  72-73 

of  interest  (see  Interest,  rate  of) 
Receiver 

banks  in  hands  of,  196-97 

work  of,   197 
Rediscount 

operation  of,  165 

prejudice  against,  in  United   States, 
165-66 

process  of,  38-39 

protection     of,     by     federal     reserve 
banks,   168-69 

under    l^ederal    Reserve    Act,    39-42, 
105-67 
Reports,  bank,  195-96 

of  federal  reserve  banks,  196,  264 

of  Federal   Reserve  Board,  197,  260 
Reserve 

amount  and  transfer  of,  under  Fed- 
eral Reserve  Act,  156-59 

capital   and,   147-76 

deposit   of,    in   reserve   cities,   61-62, 
152-58 

effect  upon,  of  Federal  Reserve  Act, 
159-60 

expense   of  maintaining,   161 

under  Federal  Reserve  Act,  161-62 

gold,  an  item  in  cost  of  banking,  291 

government  finance  and  reserve  sys- 
tem, 269,79 

grouping  of,   154-56 

maintaining  of,    ]  52-54,   189-90 

restoring   the,    162-63 

table  of,   158-59 
Reserve  cities,  61-62,  153,  155,   157-58 

Secretary  of  the  Treasury,  position  of, 
on    Federal    Reserve    Board,    255, 
262-63 
Security 

bond,   difficulties  of,  96-9S 
collateral,   26-28 
personal,  forms  of,  23-26 
Speculation,  American  hanks  an  agency 

in  service  of,  286 
State  banks 

control  of,  197-98 

development  of,  212-18  „ 

early  growth  of,  208-9 

members  of  reserve  system,  329-30 


Statement,   bank,    177-84 

bonds,  181 

capital,  178 

deposits,  178 

dividends,   180 

expenses,  180-81 

form  of  national  183-84 

form  or  state,  182 

items  entering  into,  178-81,  183 

loans,   179 

nature  of,  177 

overdrafts,   183 

solvency  as  shown  by,  184 

undivided  profits,   180 

variations  in,  182 
Stock   exchange,    closing   of,    upon   an- 
nouncement of  European  war,  127- 
28 
Supervision  of  banking 

(See  also  Government  control) 

relation    between    federal    and    state 
governments  in,  198 
Surplus 

bank,   148-50 

difficulties,   234-35 

government,  230-31,   270-74 
System 

banking,   296-99,   319-21 

(See  also  Banking  systems) 

branch    banking,    319 

Canadian  banking,   95.  318-20 
(See  also  Canadian  banking) 

check  collection,  69-70 

development  of,  under  National  Bank 
Act,  226-28 

independent  Treasury,  200-1,  219-20, 
269-75,   277-79 
(See  also   Treasury,   independent) 

national    banking,    20-21 

national  clearing,  under  Federal   Re- 
serve Act,   116-18 

New   England,   213-14 

New  York,  216-17 

note  redemption,  93-95 

Scotch  banking,  305-8 

state  banking,  control  of,   197-98 

Suffolk,  214-16 

Trade,  foreign 

financing   of,   74-83,    292-94 

loans  in,  29-31,  80-82 
Treasury 

and  the  banks,  221-22 

independent,    200-1,    219-20,    269-75, 
277-79 

redemption  of  notes  by,  9.3-95 

relations  with  reserve  system,  337 
Trust   companies,    15-16 

granting  of  powers  of.  under  Federal 
Reserve  Act,   297 

Undivided  profits,  150-52 

Vreeland  Bill.  237 


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